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Money, Interest Rates, and Exchange Rates with Endogenously Segmented Asset Markets

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Author Info
Fernando Alvarez
Andrew Atkeson
Patrick J. Kehoe

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Abstract

This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a Baumol-Tobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents' consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7871.

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Date of creation: Sep 2000
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Handle: RePEc:nbr:nberwo:7871

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References listed on IDEAS
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Fernando Alvarez & Robert E. Lucas, Jr. & Warren E. Weber, 2001. "Interest rates and inflation," Working Papers 609, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  2. Russell Cooper & Hubert Kempf, 2002. "Overturning Mundell: fiscal policy in a monetary union," Staff Report 311, Federal Reserve Bank of Minneapolis. [Downloadable!]
    Other versions:
  3. Jonathan A. Parker & Christian Julliard, 2003. "Consumption Risk and Cross-Sectional Returns," NBER Working Papers 9538, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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