Working Paper: NBER ID: w14870
Authors: S. Boragan Aruoba; Frank Schorfheide
Abstract: We develop a two-sector monetary model with a centralized and decentralized market. Activities in the centralized market resemble those in a standard New Keynesian economy with price rigidities. In the decentralized market agents engage in bilateral exchanges for which money is essential. The model is estimated and evaluated based on postwar U.S. data. We document its money demand properties and determine the optimal long-run inflation rate that trades off the New Keynesian distortion against the distortion caused by taxing money and hence transactions in the decentralized market. Target rates of -1% or less maximize the social welfare function we consider, which contrasts with results derived from a cashless New Keynesian model.
Keywords: monetary policy; inflation; DSGE model; New Keynesian; money demand
JEL Codes: C5; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nonzero inflation rates (E31) | relative price distortions (P22) |
| relative price distortions (P22) | inefficient use of intermediate goods (F12) |
| nonzero inflation rates (E31) | welfare costs (I30) |
| nominal interest rates (E43) | tax on money holdings (F38) |
| tax on money holdings (F38) | reduced activity in decentralized markets (D47) |
| target inflation rates (E31) | welfare (I38) |
| target inflation rates of 1% or less (E31) | maximizing social welfare (D69) |
| probability of firms adjusting prices (L11) | strength of New Keynesian channel (E12) |
| probability of households engaging in bilateral exchange (D16) | influence on Friedman channel (C22) |