ENDOGENOUSLY SEGMENTED ASSET MARKET IN AN INVENTORY-THEORETIC MODEL OF MONEY DEMAND

Abstract

This paper studies the effects of monetary policy in an inventory-theoretic model of money demand. In this model, agents keep inventories of money, despite the fact that money is dominated in rate of return by interest-bearing assets, because they must pay a fixed cost to transfer funds between the asset market and the goods market. In contrast to exogenous segmentation models in the literature, the timing of money transfers is endogenous. As a result, the model endogenizes the degree of market segmentation as well as the magnitudes of liquidity effects, price sluggishness, and the variability of velocity. I first show that the endogenous segmentation model can generate the positive long-run relationship between money growth and velocity observed in the data, which the exogenous segmentation model fails to capture. I also show that the short-run effects of money shocks on prices, inflation, and nominal interest rates are not robust.