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The empirical literature on monetary policy shocks documents that contrac- tionary shocks are followed by a persistent rise in interest rates and a persis- tent fall in output. Standard monetary business cycle models can account for the initial effects of monetary shocks, but have difficulty generating persistence. In this paper, I examine whether frictions that affect the asset allocation decisions of households can lead to persistent effects. In the model economy, households hold two assets, one used for transactions (the checking account) and one used for investment (the savings account). There is a small transaction cost for moving funds between the accounts. Another key feature of the economy is that the busi- ness sector accumulates retained earnings and credits profits to the consumers only with a delay. I show that in this environment monetary shocks have persis- tent effects even when the adjustment cost is very small.

Show me the money : retained earnings and the real effects of monetary shocks