Journal of Finance and Bank Management

Interest Rates, Product Prices and Trade Credit Terms
William Lim and Muhammad Rashid

Abstract
Empirical studies document that the full effect of monetary policy is not passed through to trade credit terms or product prices. We illustrate this numerically in a partial equilibrium model of third-degree price discrimination. Our computations show that trade credit terms and product prices are stable even with large changes in macroeconomic interest rates. When menu costs are considered, we find that the increase in NPV from optimizing trade credit terms and product prices is less than even miniscule menu costs for short-term interest rate changes in low-inflation periods. Therefore, the Meltzer (1960) effect holds and trade credit terms and product prices remain unchanged. However, in high inflation periods when nominal interest rates exceed a certain threshold, it becomes optimal for firms to change the terms of credit and product prices. Finally, we discuss exchange rate pass-throughs and the effectiveness of monetary easing in a pandemic.

Full Text: PDF     DOI: 10.15640/jfbm.v10n1a1