Endogenous Production Networks and Non-Linear Monetary Transmission

Abstract

I develop a tractable sticky-price model, where input-output linkages are formed endogenously through firms' optimizing decisions. My model delivers cyclical properties of networks that are consistent with those I estimate using aggregate, sectoral and rm-level data, both unconditionally and conditional on identied real and monetary shocks. Crucially, I show that my model jointly rationalizes multiple empirically documented non-linearities associated with monetary transmission, which cannot be explained by workhorse models. First, the magnitude of real GDP's response to a monetary shock is procyclical in my model. This cycle dependence occurs because in expansions the level of productivity is high, encouraging firms to connect to more suppliers, which in turn facilitates stronger downstream propagation of price rigidity. Second, short-run non-neutrality of real GDP is higher following periods of loose monetary policy. The latter path dependence happens as under nominal rigidities, higher supply of money erodes the real prices charged by suppliers, encouraging more connections and hence a stronger contagion of stickiness to customer rms. Third, large monetary expansions make the production network denser, and hence have a disproportionally larger effect than small monetary expansions; on the other hand, large monetary contractions break the network and hence have a disproportionally smaller effect on GDP. The latter size dependence holds even under fully time-dependent pricing.

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