João Ritto (University of Toronto)

Search frictions in the product market have been widely studied as a foundation of monetary theory. More recently, they have also been advanced as a possible explanation for demand-side fluctuations. This paper develops a monetary model with product market search frictions to evaluate the quantitative relevance of these frictions to the short-term effects of monetary policy on output. In the model, due to matching uncertainty in the product market, firms operate with unutilized capacity and households carry unused liquidity, and changes to the nominal interest rate have effects on output. I discipline the degree of matching uncertainty by its implications on money velocity and capacity utilization. Absent matching uncertainty, a one percent reduction in the nominal interest rate increases consumption by 0.07%. Matching uncertainty can amplify this effect by a factor of four.