New Micro-foundations for Macroeconomics
"Inflation and Interest Rates with Endogenous Market Segmentation"
Aubhik Khan (Ohio State University)
Saturday 11 July, 9.00 - 9.45
Abstract
We examine a monetary economy wherein endogenous asset market segmentation permits the extent
of household participation in open market operations to smoothly vary with changes in aggregate
conditions. While we impose no stickiness at the microeconomic level in either prices or portfolio
adjustment, we find that our flexible asset market segmentation can deliver gradual adjustment in
the aggregate price level following a monetary shock and thus persistent non-neutralities.
In our model economy, households incur fixed transactions costs when exchanging bonds and money
and, as a result, carry money balances in excess of current spending to limit the frequency of such
trades. As only a fraction of households choose to actively trade bonds and money at any given
time, the market is endogenously segmented. Moreover, because our households have the ability to
alter the timing of their trading activities, the extent of market segmentation varies over time in
response to real and nominal shocks. We show that this added flexibility can substantially reinforce
both sluggishness in aggregate price adjustment, and the persistence of liquidity effects in real and
nominal interest rates, relative to models with exogenously segmented asset markets.