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Markets Segmentation and the Hump-Shaped Response of Output to Monetary Policy Shocks

Filippo Occhino ()

No 295, 2004 Meeting Papers from Society for Economic Dynamics

Abstract: After a contractionary monetary policy shock, aggregate output decreases over time, with a trough after four to eight quarters. This paper replicates the delayed response of output using a segmented markets model where some households do not participate in financial markets. A contractionary monetary policy shock is modeled as an unanticipated increase in the nominal interest rate. Firms need money to finance production and workers receive wages with delay. An increase in the nominal interest rate, then, shifts both the labor demand and the labor supply curve to the left, and decreases the equilibrium labor and production. In a benchmark full participation model, the effect is strongest in the impact period and decays over time. When some households do not participate in financial markets, however, the monetary policy shock has an additional liquidity effect, increases the real interest rate, increases the growth rates of consumption and leisure of participating households, and decreases the growth rate of their labor supply. When markets are segmented enough, the trough of the equilibrium labor and output response occurs after several quarters. The model is able to replicate the sign, the magnitude and the persistence of the responses of output, money, prices, wages, and interest rates. In particular, a contractionary shock increases the interest rates, and decreases output, money, prices and the real wage. The model can replicate the increase in the real interest rate together with the decrease in the output growth rate. The inflation rate is endogenously persistent.

Keywords: limited participation; markets segmentation; monetary policy shocks; hump-shaped delayed response (search for similar items in EconPapers)
JEL-codes: E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
Date: 2004
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Working Paper: Market Segmentation and the 'Hump-Shaped' Response of Output to Monetary Policy Shocks (2004) Downloads
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