Customer Capital and the Markup Channel of Monetary Policy

Abstract

We study the role of customer capital in the transmission of monetary policy. We embed the deep-habit model of customer capital into a heterogeneous firm New Keynesian model with Kimball demand. Quantitatively, we find that the interaction of customer capital and variable demand elasticities amplifies the output effect of monetary policy by 50% through a markup channel: In response to an interest rate cut, larger firms invest more in customer capital by reducing prices more, further lowering the aggregate markup due to reallocation. Empirically, we find evidence for the heterogeneous responses in Compustat data. We discuss how our results relate to the price puzzle in the impulse responses of identified monetary policy shocks.