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Intertemporal Substitution and the Liquidity Effect in a Sticky Price Model

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  • J. Andres

    (Banco de Espana and Universidad de Valencia)

  • J. D. Lopez-Salido

    (Banco de Espana)

  • Javier Valles

    (Banco de Espana)

Abstract

The liquidity effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper seeks to understand under what conditions such an effect can be explained in a general equilibrium model with sticky prices and capital adjustment costs. The paper first confirms that, with separable preferences, a low degree of intertemporal substitution in consumption is a necessary condition for the existence of the liquidity effect. Contrary to this result, in a model with non-separable preferences and capital accumulation it takes an implausibly high degree of intertemporal substitution to produce a liquidity effect. The robustness of these results to alternative degrees of nominal rigidities, money demand properties and real rigidities is also analyzed.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1698.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1698

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  1. Sbordone, Argia M., 2002. "Prices and unit labor costs: a new test of price stickiness," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(2), pages 265-292, March.
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  11. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1997. "Monetary Shocks and Real Exchange Rates in Sticky Price Models of International Business Cycles," NBER Working Papers 5876, National Bureau of Economic Research, Inc.
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Cited by:
  1. Giammarioli, Nicola & Valla, Natacha, 2003. "The natural real rate of interest in the euro area," Working Paper Series, European Central Bank 0233, European Central Bank.
  2. Andreas Schabert, 2004. "On the relevance of open market operations for the short-run effects of monetary policy," Money Macro and Finance (MMF) Research Group Conference 2003, Money Macro and Finance Research Group 83, Money Macro and Finance Research Group.
  3. Stéphane Auray & Beatriz de Blas, 2009. "On Stickiness, Cash in Advance, and Persistence," Cahiers de recherche, Departement d'Economique de la Faculte d'administration à l'Universite de Sherbrooke 09-19, Departement d'Economique de la Faculte d'administration à l'Universite de Sherbrooke.
  4. Galí, Jordi & Lopez-Salido, Jose David & Vallés Liberal, Javier, 2002. "Technology Shocks and Monetary Policy: Assessing the Fed's Performance," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3211, C.E.P.R. Discussion Papers.
  5. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, Elsevier, vol. 33(C), pages 620-630.
  6. Jordi Gali, 2002. "New Perspectives on Monetary Policy, Inflation, and the Business Cycle," NBER Working Papers 8767, National Bureau of Economic Research, Inc.
  7. Piti Disyatat, 2008. "Monetary policy implementation: Misconceptions and their consequences," BIS Working Papers 269, Bank for International Settlements.
  8. Fung, Ka Wai Terence & Lau, Chi Keung Marco & Chan, Kwok Ho, 2013. "A R&D Based Real Business Cycle Model," MPRA Paper 52571, University Library of Munich, Germany.
  9. Edge, Rochelle M., 2007. "Time-to-build, time-to-plan, habit-persistence, and the liquidity effect," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(6), pages 1644-1669, September.

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