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

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  • Ricardo Lagos

Abstract

I present 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. I characterize a family of optimal monetary policies, and find that the resulting equity prices are independent of monetary considerations. I also study monetary policies that target a constant, but nonzero, nominal interest rate, and find 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 Minneapolis in its journal Quarterly Review.

Volume (Year): (2010)
Issue (Month): July ()
Pages: 14-20

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Handle: RePEc:fip:fedmqr:y:2010:i:july:p:14-20:n:v.33no.1

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  1. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  2. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
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Cited by:
  1. Aleksander Berentsen & Alessandro Marchesiani & Christopher J. Waller, 2010. "Channel systems: Why is there a positive spread?," Working Papers 2010-049, Federal Reserve Bank of St. Louis.
  2. Aleksander Berentsen & Alessandro Marchesiani & Christopher J. Waller, 2013. "Floor systems for implementing monetary policy: Some unpleasant fiscal arithmetic," ECON - Working Papers 121, Department of Economics - University of Zurich, revised Sep 2013.
  3. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.

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