Monetary policy in a two-sector dependent economy

In this paper we examine the effects of monetary policy in a two sector dependent economy. The households consume both tradable and non-tradable goods with inelastic labor supply. The economy produces both goods with labor and capital as inputs. Factors of production are mobile across sectors. The effects of monetary policy very much depend on the role of money in the economy as well as relative capital intensities. For example, when the nontraded sector is more capital intensive and households need cash for purchasing tradable goods, higher inflation will generate more investment in the economy leading to a higher level of capital stock and a lower level of net foreign assets in the long run. However, the long run effects are completely opposite if households need real balances for purchasing nontradable goods instead. All other possible cases are examined. We also calibrate the model with standard parameter values for quantitative analysis.