The effects of working capital channel on monetary policy transmission

Abstract

This thesis examines the effects of the working capital channel on monetary policy transmission under a two-sector new Keynesian model, where one of the sectors has working capital requirements. The model follows the framework presented by Woodford (2003). Introducing working capital into the model brings about two additional monetary policy transmission channels: the working capital channel and the substitution channel, relative to the standard new Keynesian model. The working capital channel reduces the effectiveness of monetary policy in stabilizing inflation within the model while also increasing the sensitivity of the output gap to monetary policy. Simultaneously, the substitution channel helps mitigate the impact of working capital on aggregate inflation. Moreover, the presence of the working capital channel gives rise to the distributional effects of monetary policy on the economy. The substitution channel exacerbates the adverse effect of contractionary policy on firms with working capital requirements, whereas expansionary monetary policy leads to a higher demand for the goods produced by these firms.