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Asset prices, liquidity, and monetary policy in the search theory of money

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  • Ricardo Lagos

Abstract

The author presents a search-based model in which money coexists with equity shares on a risky aggregate endowment. Agents can use equity as a means of payment, so shocks to equity prices translate into aggregate liquidity shocks that disrupt the mechanism of exchange. The author characterizes a family of optimal monetary policies and finds that the resulting equity prices are independent of monetary considerations. The author also studies monetary policies that target a constant, but nonzero, nominal interest rate and finds that to the extent that a financial asset is valued as a means to facilitate transactions, the asset's real rate of return will include a liquidity return that depends on monetary considerations. Through this liquidity channel, persistent deviations from an optimal monetary policy can cause the real prices of assets that can be used to relax trading constraints to exhibit persistent deviations from their fundamental values.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2010)
Issue (Month): May ()
Pages: 303-310

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Handle: RePEc:fip:fedlrv:y:2010:i:may:p:303-310:n:v.92no.4

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Keywords: Monetary policy ; Financial markets;

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  1. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report, Federal Reserve Bank of Minneapolis 373, Federal Reserve Bank of Minneapolis.
  2. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report, Federal Reserve Bank of Minneapolis 346, Federal Reserve Bank of Minneapolis.
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Cited by:
  1. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2010. "Channel Systems: Why is there a Positive Spread?," CESifo Working Paper Series 3251, CESifo Group Munich.
  2. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2014. "Floor Systems for Implementing Monetary Policy: Some Unpleasant Fiscal Arithmetic," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 523-542, July.
  3. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, Elsevier, vol. 58(3), pages 191-205.

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