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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. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
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Cited by:
  1. Galí, Jordi, 2002. "New Perspectives on Monetary Policy, Inflation and the Business Cycle," CEPR Discussion Papers 3210, C.E.P.R. Discussion Papers.
  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 83, Money Macro and Finance Research Group.
  3. Edge, Rochelle M., 2007. "Time-to-build, time-to-plan, habit-persistence, and the liquidity effect," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1644-1669, September.
  4. Jordi Galí & David López-Salido & Javier Vallés, 2000. "Technology Shocks and Monetary policy: Assessing the Fed's Performance," Banco de Espa�a Working Papers 0013, Banco de Espa�a.
  5. Stéphane Auray & Beatriz de Blas, 2009. "On Stickiness, Cash in Advance, and Persistence," Cahiers de recherche 09-19, Departement d'Economique de la Faculte d'administration à l'Universite de Sherbrooke.
  6. Giammarioli, Nicola & Valla, Natacha, 2003. "The natural real rate of interest in the euro area," Working Paper Series 0233, European Central Bank.
  7. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, vol. 33(C), pages 620-630.
  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. Piti Disyatat, 2008. "Monetary policy implementation: Misconceptions and their consequences," BIS Working Papers 269, Bank for International Settlements.

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