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Efficient monetary allocations and the illiquidity of bonds

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  • Boel, Paola
  • Camera, Gabriele

Abstract

We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with both money and nominal government bonds, but all trades must be monetized. We demonstrate that a deflationary policy a la Friedman cannot sustain the efficient allocation. The reason is that no-arbitrage imposes a stringent bound on the return money can pay. The efficient allocation can be sustained when bonds have positive yields and under certain conditions only if they are illiquid. Illiquidity meaning bonds cannot be transformed into consumption as efficiently as cash is necessary to eliminate arbitrage opportunities.
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  • Boel, Paola & Camera, Gabriele, 2006. "Efficient monetary allocations and the illiquidity of bonds," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1693-1715, October.
    • Handle: RePEc:eee:moneco:v:53:y:2006:i:7:p:1693-1715
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    More about this item

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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