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Persistent Liquidity Effect and Long Run Money Demand

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  • Fernando Alvarez

    (University of Chicago)

  • Francesco Lippi

    (University of Sassari, EIEF)

Abstract

We present a monetary model in the presence of segmented asset markets that implies 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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Bibliographic Info

Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1017.

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Length: 62 pages
Date of creation: 2010
Date of revision: Oct 2010
Handle: RePEc:eie:wpaper:1017

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  1. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(5), pages 1078-1098, October.
  2. Leeper, Eric M. & Gordon, David B., 1992. "In search of the liquidity effect," Journal of Monetary Economics, Elsevier, Elsevier, vol. 29(3), pages 341-369, June.
  3. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research, National Bank of Belgium 146, National Bank of Belgium.
  4. Darrell Duffie & Bruno Strulovici, 2009. "Capital Mobility and Asset Pricing," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1478, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Pierre-Olivier Weill & Chris Edmond, 2008. "Aggregate implications of micro asset market segmentation," 2008 Meeting Papers 481, Society for Economic Dynamics.
  6. Fernando Alvarez & Francesco Lippi, 2007. "Financial Innovation and the Transactions Demand for Cash," EIEF Working Papers Series 0807, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2007.
  7. Juan Pablo Medina & Ruy Lama, 2005. "Optimal Monetary Policy in a Small Open Economy under Segmented Asset Markets and Sticky Prices," 2005 Meeting Papers, Society for Economic Dynamics 774, Society for Economic Dynamics.
  8. John B. Carlson & Dennis L. Hoffman & Benjamin D. Keen & Robert H. Rasche, 1999. "Results of a study of the stability of cointegrating relations comprised of broad monetary aggregates," Working Paper 9917, Federal Reserve Bank of Cleveland.
  9. Bilbiie, Florin O., 2008. "Limited asset markets participation, monetary policy and (inverted) aggregate demand logic," Journal of Economic Theory, Elsevier, Elsevier, vol. 140(1), pages 162-196, May.
  10. Acharya, Viral V. & Shin, Hyun Song & Yorulmazer, Tanju, 2009. "A Theory of Slow-Moving Capital and Contagion," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7147, C.E.P.R. Discussion Papers.
  11. Tomoyuki Nakajima, 2006. "Monetary policy with sticky prices and segmented markets," Economic Theory, Springer, Springer, vol. 27(1), pages 163-177, 01.
  12. Amartya Lahiri & Rajesh Singh & Carlos A. Vegh, 2007. "Segmented Asset Markets and Optimal Exchange Rate Regimes," NBER Working Papers 13154, National Bureau of Economic Research, Inc.
  13. Filippo Occhino, 2004. "Modeling the Response of Money and Interest Rates to Monetary Policy Shocks: A Segmented Markets Approach," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 181-197, January.
  14. Thomas J. Sargent & Paolo Surico, 2011. "Two Illustrations of the Quantity Theory of Money: Breakdowns and Revivals," American Economic Review, American Economic Association, American Economic Association, vol. 101(1), pages 109-28, February.
  15. Pedro Teles & Ruilin Zhou, 2005. "A stable money demand: Looking for the right monetary aggregate," Economic Perspectives, Federal Reserve Bank of Chicago, Federal Reserve Bank of Chicago, issue Q I, pages 50-63.
  16. John B. Carlson & Benjamin D. Keen, 1996. "MZM: a monetary aggregate for the 1990s?," Economic Review, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, issue Q II, pages 15-23.
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Cited by:
  1. Jaccard, Ivan, 2013. "Liquidity constraints, risk premia, and themacroeconomic effects of liquidity shocks," Working Paper Series, European Central Bank 1525, European Central Bank.
  2. Mumtaz, Haroon & Zabczyk, Pawel & Ellis, Colin, 2011. "What lies beneath? A time-varying FAVAR model for the UK transmission mechanism," Working Paper Series, European Central Bank 1320, European Central Bank.
  3. 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.

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