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Money, Bonds, and the Liquidity Trap

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  • LUIS ARAUJO
  • LEO FERRARIS

Abstract

This paper examines a search model of money and public bonds in which coordination frictions lead to multiple, Pareto ranked equilibria. Whether money and bonds are substitutes or complements, is not a primitive of the economy, but an equilibrium outcome. There exists an equilibrium resembling a liquidity trap, in which money and bonds are perfect substitutes, interest rates are zero, and monetary policy is ineffective; and a superior equilibrium in which money and bonds are complements, interest rates are positive and monetary policy has a liquidity effect. On this view, the liquidity trap is a belief‐driven phenomenon.

Suggested Citation

  • Luis Araujo & Leo Ferraris, 2020. "Money, Bonds, and the Liquidity Trap," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(7), pages 1853-1867, October.
    • Handle: RePEc:wly:jmoncb:v:52:y:2020:i:7:p:1853-1867
    DOI: 10.1111/jmcb.12697
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    References listed on IDEAS

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    Cited by:

    1. Nicola Amendola & Lorenzo Carbonari & Leo Ferraris, 2021. "Three Liquid Assets," Working Paper series 21-14, Rimini Centre for Economic Analysis.
    2. Gu, Chao & Monnet, Cyril & Nosal, Ed & Wright, Randall, 2023. "Diamond–Dybvig and beyond: On the instability of banking," European Economic Review, Elsevier, vol. 154(C).

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