The cost channel of monetary transmission–revisited

Abstract

This article empirically re-examines the importance of the cost channel of monetary transmission–the effect of money supply shocks on the costs of production and supply, as opposed to the traditional effect on demand. Unlike Barth and Ramey (2002), this article identifies the response of industry-level wages to money supply shocks by assuming long-run monetary neutrality. The pervasive findings of a positive response of real wages to money supply shocks in this study provide even stronger support for the cost channel than Barth and Ramey (2002).

Notes

¹ See also Hamilton, 1994, pp. 309–13 and Theil, 1971, p. 309.

² Blanchard and Quah (1989) and Shapiro and Watson (1988) pioneered the use of infinite-horizon restrictions to identify structural VARs. Faust and Leeper (1997) point out some pitfalls in the approach.

³ The industries are: apparel, chemicals, construction, durable goods, electronic equipment, fabricated metal products, finance, food products, furniture, machinery equipment, instruments, leather, lumber and wood, manufacturing, mining, miscellaneous manufacturing, nondurable goods, paper, primary metal, printing, retail trade, stone and clay, textile, transportation equipment, public utility and wholesale trade.

⁴ The main results in this study were insensitive to alternatives for the macro proxies such as M2.

⁵ This article does not report the responses of the macro variables to save space, but they match with the priors: aggregate output responds positively with a hump-shape, interest rates fall and the price level, while sticky in the short-run, gradually rises to a permanently higher level in the long-run. These results add to the justification of the identification scheme based on monetary neutrality in the long-run.