A Monetary Model with Multiple Trading Rounds and Consumption Transaction Cost

The paper introduces the economy that has a cash-in-advance monetary structure similar to the one presented in Lucas and Stokey (1987), Nakajima and Polemarchakis (2005) and Peiris and Vardoulakis (2015). The model is a two period model, each period has N trading rounds. There is consumption transaction cost which is an increasing function of number of trading rounds. The paper studies a competitive market clearing equilibrium. The real interest rate is fixed as there is no production in the economy: agents are endowed with goods and sell them by equal fractions each trading rounds. Consumption happens during each round as an equal fraction of total consumption of the period. The paper studies properties of compatible transaction cost functions and chooses one of the simplest forms for further analysis. It shows that an increased interest rate will increase the number of trading rounds/trips to the bank and decrease money demand. More importantly, the paper shows that inflation can depend either positively or negatively on interest rate and hence there is a point of minimum of inflation as shown in the last section of the paper. Inflation as a function of interest rate is U-shaped, which is a distinctive feature of the model. Fixing real interest rate the paper studies the effect of interaction between inter-temporal elasticity of substitution and transaction cost function on interest rate elasticity of money demand and inflation. The papers most interesting part answers the question of how interest rate elasticities of money demand and inflation are affected by changing transaction cost of money. The paper showed that in a standard flexible price economy the interest rate elasticity of inflation rate is positive holding real interest rate constant, but the paper also showed that it is not the property of a flexible price economy, but the property of the transaction cost function in my model.