Endogenous Production Networks and Non-Linear Monetary Transmission

Title: Endogenous Production Networks and Non-Linear Monetary Transmission

Abstract: I develop a tractable sticky-price model, where input-output linkages are formed endogenously. The model delivers cyclical properties of networks that are consistent with those I estimate using sectoral and firm-level data, conditional on identified real and nominal shocks. A novel source of state dependence in nominal rigidities arises: the strength of complementarities in price setting and monetary non-neutrality increase in the number of suppliers that firms optimally choose to have. As a result, the model simultaneously rationalizes the following observed non-linearities in monetary transmission. First, the model produces cycle dependence: the magnitude of real GDP's response to a monetary shock is procyclical. This occurs because in expansions the level of productivity is high, encouraging cost-minimizing firms to connect to more suppliers, which makes pricing decisions more co-ordinated and monetary non-neutrality stronger. Second, there is path dependence: non-neutrality of real GDP is higher following previous periods of loose monetary policy. This happens as under nominal rigidities higher supply of money makes prices charged by suppliers cheap relative to the cost of in-house labor, encouraging more connections and strengthening pricing complementarities. Third, there is size dependence: larger monetary expansions make the network denser and have a disproportionally larger effect on GDP than smaller expansions. On the other hand, larger monetary contractions shrink the network and generate a disproportionally smaller decrease in GDP. Such size dependence holds even if the probability of price adjustment is state-independent.

Link to Paper: Ghassibe_jmp.pdf (ghassibem.github.io)