A Transactions-Based Model of the Monetary Transmission Mechanism

Grossman and Weiss build a transactions-based model of money demand – a hybrid of Clower’s (1967) cash-in-advance constraint and the Baumol-Tobin inventory-theoretic approach – in which going to the bank to convert interest-bearing assets into cash is costly, so consumers withdraw cash periodically rather than continuously, withdrawals are staggered across the population, and at any instant agents hold different amounts of cash. The paper’s central result is that these three realistic-but-usually-ignored features of actual monetary economies together imply that an open market purchase of bonds for money is not neutral: because only the consumers currently at the bank absorb the new cash, they must be induced to hold a disproportionately large share of the monetary injection, which requires both real and nominal interest rates to fall; because the newly injected money is then spent only gradually as those consumers draw down their balances before their next bank trip, the price level rises slowly rather than jumping immediately, even though all prices in the model are completely flexible. Under logarithmic utility, these effects are damped and persistent, and the paper argues from U.S. money-velocity data that the resulting price-adjustment transition takes on the order of fifteen weeks – a result the authors contrast with traditional Keynesian “short-run price stickiness” stories, since in this model prices are flexible throughout and the apparent “short run versus long run” distinction instead reflects whether the cross-sectional distribution of money holdings across consumers has been given time to re-equilibrate.

Sanford J. Grossman | Macro Paper Warehouse

A Transactions-Based Model of the Monetary Transmission Mechanism