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Monetary Policy and Asset Prices

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Author Info

  • Athanasios Geromichalos

    (University of Pennsylvania)

  • Juan M Licari

    (University of Pennsylvania)

  • Jose Suarez-Lledo

    (University of Pennsylvania)

Abstract

The purpose of this paper is study the effect of monetary policy on asset prices. We study the properties of a monetary model in which a real asset is valued for its rate of return and for its liquidity. We show that money is essential if and only if real assets are scarce, in the precise sense that their supply is not sufficient to satisfy the demand for liquidity. Our model generates a clear connection between asset prices and monetary policy. When money grows at a higher rate, inflation is higher and the return on money decreases. In equilibrium, no arbitrage amounts to equating the real return of both objects. Therefore, the price of the asset increases in order to lower its real return. This negative relationship between inflation and asset returns is in the spirit of research in finance initiated in the early 80's. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2007.03.002
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 10 (2007)
Issue (Month): 4 (October)
Pages: 761-779

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Handle: RePEc:red:issued:06-213

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Related research

Keywords: Liquidity; Monetary policy; Inflation; Asset pricing; Asset returns;

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References

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  1. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  2. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  3. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  4. Ricardo Lagos & Guillaume Rocheteau, 2004. "Money and capital as competing media of exchange," Staff Report 341, Federal Reserve Bank of Minneapolis.
  5. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
  6. Lagos, Ricardo & Wright, Randall, 2003. "Dynamics, cycles, and sunspot equilibria in 'genuinely dynamic, fundamentally disaggregative' models of money," Journal of Economic Theory, Elsevier, vol. 109(2), pages 156-171, April.
  7. Danthine, Jean-Pierre & Donaldson, John B, 1986. "Inflation and Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 54(3), pages 585-605, May.
  8. Marshall, David A, 1992. " Inflation and Asset Returns in a Monetary Economy," Journal of Finance, American Finance Association, vol. 47(4), pages 1315-42, September.
  9. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
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Citations

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Cited by:
  1. Ina Simonovska & Athanasios Geromichalos, 2011. "Asset Liquidity and International Portfolio Choice," 2011 Meeting Papers 756, Society for Economic Dynamics.
  2. Athanasios Geromichalos & Lucas Herrenbrueck, 2012. "Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets," Working Papers 1220, University of California, Davis, Department of Economics.
  3. Irina A. Telyukova & Randall Wright, 2007. "A model of money and credit, with application to the credit card debt puzzle," Working Paper 0711, Federal Reserve Bank of Cleveland.
  4. José Suárez-Lledó, 2009. "Monetary Policy with Heterogeneous Collateralized Borrowing," Working Papers 374, Barcelona Graduate School of Economics.
  5. Guillaume Rocheteau & Randall Wright, 2010. "Liquidity and asset market dynamics," Working Paper 1016, Federal Reserve Bank of Cleveland.
  6. Yu Zhu & Randall Wright & Chao He, 2012. "Housing and Liquidity," 2012 Meeting Papers 94, Society for Economic Dynamics.
  7. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  8. David Andolfatto & Fernando Martin, 2013. "Information Disclosure and Exchange Media," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(3), pages 527-539, July.
  9. Ricardo Lagos, 2009. "Asset Prices, Liquidity, and Monetary Policy in an Exchange Economy," 2009 Meeting Papers 390, Society for Economic Dynamics.
  10. Benjamin Lester & Andrew Postlewaite & Randall Wright, 2008. "Information, Liquidity and Asset Prices," PIER Working Paper Archive 08-039, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  11. Young Sik Kim & Manjong Lee, 2012. "Recognizability and Liquidity of Assets," Discussion Paper Series 1206, Institute of Economic Research, Korea University.
  12. Guillaume Rocheteau & Pierre-Olivier Weill, 2011. "Liquidity in frictional asset markets," Working Paper 1105, Federal Reserve Bank of Cleveland.
  13. Guillaume Rocheteau, 2008. "Money and competing assets under private information," Working Paper 0802, Federal Reserve Bank of Cleveland.
  14. Randall Wright & Vaidyanathan (Venky) Venkateswaran, 2012. "Pledgability and Liquidity," 2012 Meeting Papers 601, Society for Economic Dynamics.
  15. Ferraris, Leo & Watanabe, Makoto, 2011. "Collateral fluctuations in a monetary economy," Journal of Economic Theory, Elsevier, vol. 146(5), pages 1915-1940, September.
  16. Aleksander Berentsen & Samuel Huber & Alessandro Marchesiani, 2012. "Degreasing the wheels of finance," ECON - Working Papers 101, Department of Economics - University of Zurich.
  17. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
  18. Randall Wright & Guillaume Rocheteau, 2011. "Liquidity and Asset Market Dynamics," 2011 Meeting Papers 103, Society for Economic Dynamics.
  19. Guillaume Rocheteau, 2009. "Information and liquidity: a discussion," Working Paper 0902, Federal Reserve Bank of Cleveland.

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