Hostname: page-component-669899f699-7tmb6 Total loading time: 0 Render date: 2025-05-03T01:01:22.567Z Has data issue: false hasContentIssue false
  • English
  • Français

Money demand by firms, labor market frictions, and optimal long-run inflation

Published online by Cambridge University Press:  14 February 2023

Mehrab Kiarsi
Mehrab Kiarsi*
Affiliation:
School of Economics, Henan University, Kaifeng, China
*
Email: [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

Optimal monetary policy, under flexible and sticky prices, and sticky nominal wages are studied in the canonical matching model of the labor market with a working capital channel. A money demand by firms is motivated by the fact that a significant amount of M1 is held by firms. As a result of the working capital, the Ramsey-optimal monetary policy calls for inflation when employment is above the socially efficient level and for deflation when it is below that level. This result holds under flexible wages as well as nominal wage rigidities. In other words, to improve labor market efficiency, deflation is necessary to “grease the wheels of the labor market.” Although there is no relationship between optimal monetary policy and the market tightness under flexible prices, a long-run and mainly negative relationship between the optimal inflation rate and the equilibrium tightness emerges under sticky prices.

Keywords

Optimal monetary policyfrictional labor marketsworking capital channel
Type
Articles
Information
Macroeconomic Dynamics , Volume 28 , Issue 1 , January 2024 , pp. 204 - 233
Copyright
© The Author(s), 2023. Published by Cambridge University Press

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

Footnotes

*

I am grateful to the Associate Editor and two anonymous referees for their helpful comments. I am also grateful to Mohammad Davoodalhosseini for his valuable time and important feedback on this paper. I have also benefited from conversations with Stephanie Schmitt-Grohe and Martin Uribe during my stay at the Department of Economics of Columbia University as a research scholar.

References

Almeida, H., Campello, M. and Weisbach, M. S. (2004) The cash flow sensitivity of cash. The Journal of Finance 59(4), 1777–1804.CrossRefGoogle Scholar
Arseneau, D. M. and Chugh, S. K. (2008) Optimal fiscal and monetary policy with costly wage bargaining. Journal of Monetary Economics 55(8), 1401–1414.CrossRefGoogle Scholar
Arseneau, D. M. and Chugh, S. K. (2012) Tax smoothing in frictional labor markets. Journal of Political Economy 120(5), 926–985.CrossRefGoogle Scholar
Bacchetta, P., Benhima, K. and Poilly, C. (2019) Corporate cash and employment. American Economic Journal: Macroeconomics 11(3), 30–66.Google Scholar
Barth, M. J. and Ramey, V. A. (2002) The cost channel of monetary transmission. NBER Macroeconomics Annual 16, 199–240.CrossRefGoogle Scholar
Bates, T. W., Kahle, K. M. and Stulz, R. M. (2009) Why do U.S. firms hold so much more cash than they used to? The Journal of Finance 64(5), 1985–2021.CrossRefGoogle Scholar
Benhabib, J., Schmitt-Grohé, S. and Uribe, M. D. (2001) Monetary policy and multiple equilibria. American Economic Review 91(1), 167–186.CrossRefGoogle Scholar
Blanchard, O. and Gali, J. (2010) Labor markets and monetary policy: A new keynesian model with unemployment. American Economic Journal: Macroeconomics 2(2), 1–30.Google Scholar
Canzoneri, M., Cumby, R. and Diba, B. (2010). Chapter 17 - The interaction between monetary and fiscal policy. Handbook of Monetary Economics 3, 935–999.CrossRefGoogle Scholar
Carlsson, M. and Westermark, A. (2016) Labor market frictions and optimal steady-state inflation. Journal of Monetary Economics 78, 67–79.CrossRefGoogle Scholar
Chowdhury, I., Hoffmann, M. and Schabert, A. (2006) Inflation dynamics and the cost channel of monetary transmission. European Economic Review 50(4), 995–1016.CrossRefGoogle Scholar
Christiano, L. J., Eichenbaum, M. and Evans, C. (1996) The effects of monetary policy shocks: evidence from the flow of funds. The Review of Economics and Statistics 78(1), 16–34.CrossRefGoogle Scholar
Christiano, L. J., Eichenbaum, M. S. and Trabandt, M. (2016) Unemployment and business cycles. Econometrica 84(4), 1523–1569.CrossRefGoogle Scholar
Christiano, L. J., Trabandt, M. and Walentin, K. (2010) Chapter 7 - Dsge models for monetary policy analysis. Handbook of Monetary Economics 3, 285–367.CrossRefGoogle Scholar
Christiano, L. J., Trabandt, M. and Walentin, K. (2011) Introducing financial frictions and unemployment into a small open economy model. Journal of Economic Dynamics and Control 35(12), 1999–2041.CrossRefGoogle Scholar
Chugh, S. K. (2007) Optimal inflation persistence: Ramsey taxation with capital and habits. Journal of Monetary Economics 54(6), 1809–1836.CrossRefGoogle Scholar
Chugh, S. K. (2013) Costly external finance and labor market dynamics. Journal of Economic Dynamics and Control 37(12), 2882–2912.CrossRefGoogle Scholar
den Haan, W. J., Ramey, G. and Watson, J. (2000) Job destruction and propagation of shocks. American Economic Review 90(3), 482–498.CrossRefGoogle Scholar
Duchin, R. (2010) Cash holdings and corporate diversification. The Journal of Finance 65(3), 955–992.CrossRefGoogle Scholar
Faccini, R., Millard, S. and Zanetti, F. (2013) Financial shocks, job destruction shocks, and labor market fluctuations. Manchester School 81, 66–99.CrossRefGoogle Scholar
Faia, E. (2008) Optimal monetary policy rules with labor market frictions. Journal of Economic Dynamics and Control 32(5), 1600–1621.CrossRefGoogle Scholar
Faia, E. (2009) Ramsey monetary policy with labor market frictions. Journal of Monetary Economics 56(4), 570–581.CrossRefGoogle Scholar
Ferreira, M. A. and Vilela, A. S. (2004) Why do firms hold cash? Evidence from emu countries. European Financial Management 10(2), 295–319.CrossRefGoogle Scholar
Gali, J. (2010) Chapter 10 - Monetary policy and unemployment. Handbook of Monetary Economics 3, 487–546.CrossRefGoogle Scholar
Gao, H., Harford, J. and Li, K. (2013) Determinants of corporate cash policy: Insights from private firms. Journal of Financial Economics 109(3), 623–639.CrossRefGoogle Scholar
Garcia-Appendini, E. and Montoriol-Garriga, J. (2013) Firms as liquidity providers evidence from the 2007-2008 financial crisis. Journal of Financial Economics 109(1), 272–291.CrossRefGoogle Scholar
García-Teruel, P. J. and Martínez-Solano, P. (2008) On the determinants of sme cash holdings: Evidence from spain. Journal of Business Finance & Accounting 35(1-2), 127–149.CrossRefGoogle Scholar
Gilchrist, S., Schoenle, R., Sim, J. and Zakrajšek, E.. (March 2017) Inflation dynamics during the financial crisis. American Economic Review 107(3), 785–823.CrossRefGoogle Scholar
Hall, R. E. (March 2005) Employment fluctuations with equilibrium wage stickiness. American Economic Review 95(1), 50–65.CrossRefGoogle Scholar
Hall, R. E. and Schulhofer-Wohl, S. (2017). The pervasive importance of tightness in labor-market volatility. Working Paper, Standford University.Google Scholar
Han, S. and Qiu, J. (2007) Corporate precautionary cash holdings. Journal of Corporate Finance 13(1), 43–57.CrossRefGoogle Scholar
Kiarsi, M. and Muehlemann, S. (2021). The importance of proportional and fixed hiring costs in search and matching models. Working Paper.Google Scholar
Kim, J. and Ruge-Murcia, F. J. (2009) How much inflation is necessary to grease the wheels? Journal of Monetary Economics 56(3), 365–377.CrossRefGoogle Scholar
Kim, J. and Ruge-Murcia, F. J. (2011) Monetary policy when wages are downwardly rigid: Friedman meets tobin. Journal of Economic Dynamics and Control 35(12), 2064–2077.CrossRefGoogle Scholar
Leeper, E. M. and Leith, C. (2016) Chapter 30 - Understanding inflation as a joint monetary-fiscal phenomenon, Handbook of Macroeconomics, vol. 2, pp. 2305–2415, Elsevier.Google Scholar
Leeper, E. M., Leith, C. and Liu, D. (2020) Optimal time-consistent monetary, fiscal and debt maturity policy. Journal of Monetary Economics 117, 600–617.CrossRefGoogle Scholar
Leeper, E. M. and Zhou, X. (2021) Inflation’s role in optimal monetary-fiscal policy. Journal of Monetary Economics 124, 1–18.CrossRefGoogle Scholar
Lepetit, A. (2020a) Asymmetric unemployment fluctuations and monetary policy trade-offs. Review of Economic Dynamics 36, 29–45.CrossRefGoogle Scholar
Lepetit, A. (2020b) Asymmetric unemployment fluctuations and monetary policy trade-offs. Review of Economic Dynamics 36, 29–45.CrossRefGoogle Scholar
Ljungqvist, L. and Sargent, T. J. (2017) The fundamental surplus. American Economic Review 107(9), 2630–2665.CrossRefGoogle Scholar
Monacelli, T., Perotti, R. and Trigari, A. (2010) Unemployment fiscal multipliers. Journal of Monetary Economics 57(5), 531–553.CrossRefGoogle Scholar
Mulligan, C. B. (1997) Scale economies, the value of time, and the demand for money: Longitudinal evidence from firms. Journal of Political Economy 105(5), 1061–1079.CrossRefGoogle Scholar
Mumtaz, H. and Zanetti, F. (2016) The effect of labor and financial frictions on aggregate fluctuations. Macroeconomic Dynamics 1(1), 313–341.CrossRefGoogle Scholar
Petrongolo, B. and Pissarides, C. A. (2001) Looking into the black box: A survey of the matching function. Journal of Economic Literature 39(2), 390–431.CrossRefGoogle Scholar
Petrosky-Nadeau, N., Zhang, L. and Kuehn, L.-A. (2018) Endogenous disasters. American Economic Review 108(8), 2212–2245.CrossRefGoogle Scholar
Phelps, E. S. (1973) Inflation in the theory of public finance. The Swedish Journal of Economics 75(1), 67–82.CrossRefGoogle Scholar
Pissarides, C. A. (2009) The unemployment volatility puzzle: Is wage stickiness the answer? Econometrica 77(5), 1339–1369.Google Scholar
Ravenna, F. and Walsh, C. E. (2006) Optimal monetary policy with the cost channel. Journal of Monetary Economics 53(2), 199–216.CrossRefGoogle Scholar
Ravenna, F. and Walsh, C. E. (2011) Welfare-based optimal monetary policy with unemployment and sticky prices: A linear-quadratic framework. American Economic Journal: Macroeconomics 3(2), 130–162.Google Scholar
Ravenna, F. and Walsh, C. E. (2012) Monetary policy and labor market frictions: A tax interpretation. Journal of Monetary Economics 59(2), 180–195.CrossRefGoogle Scholar
Rendahl, P. (2016) Fiscal policy in an unemployment crisis. The Review of Economic Studies 83(3), 1189–1224.CrossRefGoogle Scholar
Rotemberg, J. J. (1982) Sticky prices in the united states. Journal of Political Economy 90(6), 1187–1211.CrossRefGoogle Scholar
Schmitt-Grohé, S. and Uribe, M. (2004) Optimal fiscal and monetary policy under sticky prices. Journal of Economic Theory 114(2), 198–230.CrossRefGoogle Scholar
Schmitt-Grohé, S. and Uribe, M. (2010) The optimal rate of inflation. Handbook of Monetary Economics 3, 653–722.CrossRefGoogle Scholar
Sims, E. and Wolff, J. (2017) State-dependent fiscal multipliers: Calvo vs. Rotemberg. Economics Letters 159, 190–194.CrossRefGoogle Scholar
Thomas, C. (2008) Search and matching frictions and optimal monetary policy. Journal of Monetary Economics 55(5), 936–956.CrossRefGoogle Scholar
Thomas, C. (2011) Search frictions, real rigidities, and inflation dynamics. Journal of Money, Credit and Banking 43(6), 1131–1164.CrossRefGoogle Scholar
Trentmann, N. and Benoit, D. (2021) Banks to companies: No more deposits. The Wall Street Journal, https://www.wsj.com/articles/banks-to-companies-no-more-deposits-please-11623238200?mod=hp_lea Google Scholar
Zanetti, F. (2019) Financial shocks, job destruction shocks, and labor market fluctuations. Macroeconomic Dynamics 3(3), 1137–1165.CrossRefGoogle Scholar