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Intertemporal substitution and the liquidity effect in a sticky price model

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  • Andres, Javier
  • David Lopez-Salido, J.
  • Valles, Javier

Abstract

The liquidity effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper seeks to understand under what conditions such an effect can be explained in a general equilibrium model with sticky prices and capital adjustment costs. The paper first confirms that, with separable preferences, a low degree of intertemporal substitution in consumption is a necessary condition for the existence of the liquidity effect. Contrary to this result, in a model with non-separable preferences and capital accumulation it takes an implausibly high degree of intertemporal substitution to produce a liquidity effect. The robustness of these results to alternative degrees of nominal rigidities, money demand properties and real rigidities is also analyzed.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 46 (2002)
Issue (Month): 8 (September)
Pages: 1399-1421

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Handle: RePEc:eee:eecrev:v:46:y:2002:i:8:p:1399-1421

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Cited by:
  1. Gali, Jordi & Lopez-Salido, J. David & Valles, Javier, 2003. "Technology shocks and monetary policy: assessing the Fed's performance," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 723-743, May.
  2. Piti Disyatat, 2008. "Monetary policy implementation: Misconceptions and their consequences," BIS Working Papers 269, Bank for International Settlements.
  3. Andreas Schabert, 2004. "On the relevance of open market operations for the short-run effects of monetary policy," Money Macro and Finance (MMF) Research Group Conference 2003 83, Money Macro and Finance Research Group.
  4. Fung, Ka Wai Terence & Lau, Chi Keung Marco & Chan, Kwok Ho, 2013. "A R&D Based Real Business Cycle Model," MPRA Paper 52571, University Library of Munich, Germany.
  5. Jordi Gali, 2002. "New Perspectives on Monetary Policy, Inflation, and the Business Cycle," NBER Working Papers 8767, National Bureau of Economic Research, Inc.
  6. Stéphane Auray & Beatriz de Blas, 2009. "On Stickiness, Cash in Advance, and Persistence," Cahiers de recherche 09-19, Departement d'Economique de la Faculte d'administration à l'Universite de Sherbrooke.
  7. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, vol. 33(C), pages 620-630.
  8. Edge, Rochelle M., 2007. "Time-to-build, time-to-plan, habit-persistence, and the liquidity effect," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1644-1669, September.
  9. Giammarioli, Nicola & Valla, Natacha, 2003. "The natural real rate of interest in the euro area," Working Paper Series 0233, European Central Bank.

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