The price effects of monetary shocks in a network economy

Abstract

Empirical evidence shows monetary shocks have two temporary effects on the distribution of prices. One, the dispersion of cross-section of prices increases in response to monetary shocks. Two, some prices change in the 'wrong' direction: some prices decrease in response to positive monetary shocks, and increase in response to negative monetary shocks. We present a model that generates the two effects of monetary shocks on the distribution of prices as an out-of-equilibrium phenomena. Firms are related to each other through a production network. Monetary shocks change the working capital of a subset of firms and percolate to other firms through buyer-seller linkages. Price dispersion increases because the percolation of a monetary shock through the production network causes prices to differentially deviate from their steady state values. Some prices change in the wrong direction because a shift in one firm's demand causes a shift in another firm's supply (and vice-versa), thereby generating complicated chains of bi-directional price changes. Monetary shocks can significantly disturb relative prices even when all prices are fully flexible.

Impact Analysis Of Monetary And Fiscal Policies On Indonesia’s Economic Growth

“…Despite its use as a countercyclical tool to stimulate economic growth, monetary policy can also lead to an increase in prices due to an increase in money supply. This outcome is consistent with the findings of previous studies (Arintoko & Kadarwati, 2022;Nyumuah, 2018;Abbasinejad et al, 2018;Sethi et al, 2019;Mandel et al, 2019;Arintoko, 2021;Tai Nguyen et al, 2022).…”

“…The relationship between economic growth and monetary policy, specifically the role of policy interest rates, was extensively examined by (Arintoko & Kadarwati, 2022) using the VAR method, which showed that policy interest rates respond positively to unexpected GDP changes. Previous studies have suggested that monetary policy plays a crucial role in regulating economic growth, inflation, and exchange rates (Nyumuah, 2018); (Abbasinejad et al, 2018); (Sethi et al, 2019); (Mandel et al, 2019) (Arintoko, 2021); (Tai Nguyen et al, 2022). (Kim & Lim, 2018) and (Kim et al, 2020) note that monetary policy shocks can affect exchange rates.…”

Does Monetary Policy Respond to Macroeconomic Shocks? Evidence from Indonesia

“…Various structural shocks that drive high inflation such as inflation shocks, output shocks, and exchange rate shocks are of greater concern to the central bank In many studies, monetary policy has an impact that includes the impact on output, inflation, and exchange rates. This empirical evidence is provided in studies conducted by, among others, Nyumuah (2018), Abbasinejad et al (2018), Sethi et al (2019), Mandel et al (2019), and Tai Nguyen et al (2022). The results of a study by Arintoko (2021) imply the important role of monetary policy in stabilizing output and inflation in the short run and stabilizing inflation in the long run.…”

Propagation of shocks in an input-output economy: Evidence from disaggregated prices

“…Previous research has already shown that there is considerable dispersion in the response of sectoral prices to monetary shocks (see Balke and Wynne, 2007 ). In a production network model with capital requirement constraints, some firms will raise prices in response to a monetary tightening or lower prices after a monetary loosening, as shown by Mandel et al (2019) .…”