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

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  • Fernando Alvarez
  • Andrew Atkeson
  • Patrick J. Kehoe

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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Bibliographic Info

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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Publication status: published as Alvarez, Fernanco, Andre Atkeson and Patrick J. Kehoe. "Money, Interest Rates, And Exchange Rates With Endogenously Segmented Markets," Journal of Political Economy, 2002, v110(1,Mar), 73-112.
Handle: RePEc:nbr:nberwo:7871

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Cited by:
  1. Jonathan A. Parker & Christian Julliard, 2005. "Consumption Risk and the Cross Section of Expected Returns," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 113(1), pages 185-222, February.
  2. Russell Cooper & Hubert Kempf, 2002. "Overturning Mundell: fiscal policy in a monetary union," Staff Report, Federal Reserve Bank of Minneapolis 311, Federal Reserve Bank of Minneapolis.
  3. Fernando Alvarez & Robert E. Lucas & Warren E. Weber, 2001. "Interest Rates and Inflation," American Economic Review, American Economic Association, American Economic Association, vol. 91(2), pages 219-225, May.
  4. Olivier F. Morand & Kevin L. Reffett, 2002. "Existence and Uniqueness of Equilibrium in Nonoptimal Unbounded Infinite Horizon Economies," Tinbergen Institute Discussion Papers, Tinbergen Institute 02-085/2, Tinbergen Institute.
  5. Mahmoudi, Babak, 2013. "Open-Market Operations, Asset Distributions, and Endogenous Market Segmentation," MPRA Paper 50089, University Library of Munich, Germany.
  6. Basak, Suleyman & Croitoru, Benjamin, 2007. "International good market segmentation and financial innovation," Journal of International Economics, Elsevier, Elsevier, vol. 71(2), pages 267-293, April.
  7. Jonathan A. Parker & Christian Julliard, 2003. "Consumption Risk and Cross-Sectional Returns," NBER Working Papers 9538, National Bureau of Economic Research, Inc.

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