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Persistent Liquidity Effects and Long Run Money Demand

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  • Fernando E. Alvarez
  • Francesco Lippi

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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17566.

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Date of creation: Nov 2011
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Handle: RePEc:nbr:nberwo:17566

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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, vol. 106(5), pages 1078-1098, October.
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Cited by:
  1. Jaccard, Ivan, 2013. "Liquidity constraints, risk premia, and themacroeconomic effects of liquidity shocks," Working Paper Series 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 1320, European Central Bank.

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