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Persistent Liquidity Effects and Long Run Money Demand

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  • Alvarez, Fernando E
  • Lippi, Francesco

Abstract

We present a monetary model in the presence of segmented asset markets that im- plies a persistent fall in interest rates after a once and for all increase in liquidity. The gradual propagation mechanism produced by our model is novel in the literature. We provide an analytical characterization of this mechanism, showing that the magnitude of the liquidity effect on impact, and its persistence, depend on the ratio of two parameters: the long-run interest rate elasticity of money demand and the intertemporal substitution elasticity. At the same time, the model has completely classical long-run predictions, featuring quantity theoretic and Fisherian properties. The model simultaneously explains the short-run "instability" of money demand estimates as-well-as the stability of long-run interest-elastic money demand.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8650.

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Date of creation: Nov 2011
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Handle: RePEc:cpr:ceprdp:8650

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Keywords: money demand;

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  1. Darrell Duffie & Bruno Strulovici, 2012. "Capital Mobility and Asset Pricing," Econometrica, Econometric Society, vol. 80(6), pages 2469-2509, November.
  2. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research 146, National Bank of Belgium.
  3. Singh, Rajesh & Lahiri, Amartya & Vegh, Carlos A, 2007. "Segmented Asset Markets and Optimal Exchange Rate Regimes," Staff General Research Papers 11446, Iowa State University, Department of Economics.
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Cited by:
  1. Wei Liao & Sampawende J.-A. Tapsoba, 2014. "China’s Monetary Policy and Interest Rate Liberalization: Lessons from International Experiences," IMF Working Papers 14/75, International Monetary Fund.
  2. Mumtaz, Haroon & Zabczyk, Pawel & Ellis, Colin, 2011. "What lies beneath? A time-varying FAVAR model for the UK transmission mechanism," Working Paper Series 1320, European Central Bank.
  3. Jaccard, Ivan, 2013. "Liquidity constraints, risk premia, and themacroeconomic effects of liquidity shocks," Working Paper Series 1525, European Central Bank.

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