It is a still open research question, what are the micro mechanisms by which monetary policy affects, and is transmitted through, the economy. There are two competing hypothesis, one sticky prices that is based on the Keynesian idea of nominal price rigidities and the other limited participation that emphasizes the inability of agents to costlessly engage in financial transactions. However, until this dissertation they were not both incorporated in a single model capable of investigating their relative importance and whether in conjunction they can explain more of the empirical regularities.
This dissertation examines the transmission of monetary policy in the US, by developing a dynamic, stochastic, general equilibrium model that nests these two classes of models. Sticky prices are incorporated by assuming that monopolistically competitive inter mediate goods-producing firms face a quadratic cost of nominal price adjustment. Limited participation is incorporated by assuming that households' utility has a quadratic cost of portfolio adjustment. Monetary policy is characterized by a generalized Taylor rule with interest rate smoothing.
The first chapter, calibrates the model and investigates whether the unified model performs better in replicating empirical stylized facts, than the models that have only sticky price or limited participation. The unified model replicates better second moments of the data than the other two types of models. It also improves on the ability of the sticky price model to deliver the response of output and inflation in hump-shape, and it also delivers the ability of the limited participation model to replicate the decrease in profits and wages, after a contractionary monetary policy.
The second chapter, estimates the model with the method of maximum likelihood. The results support the hypothesis that although the degree of the portfolio adjustment is small in the data, it is statistically significant, as price rigidities are as well. In addition, the data suggest that the response of the interest rate to deviations of output from the steady state in the interest rate rule, should be close to zero.
