Liquidity, Inflation, and Monetary Policy
AbstractIn standard monetary models nominal interest rates should be decreased in response to a switch to a lower inflation target. This paper considers this interaction between inflation and nominal interest rates in a dynamic model of liquidity. In a repeated Diamond&Dybvig economy a financial intermediation sector provides those agents with money/liquidity who urgently need it and saves for those who do not. I show when a lower inflation target requires a higher nominal interest rate. I then calibrate the model. The model fits the data very well and the response of inflation to a permanent increase in nominal interest rates is negative if nominal interest rates are low (`the market is liquid') and positive if nominal interest rates are high (`the market is illiquid')
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 677.
Date of creation: 03 Dec 2006
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Liquidity; Monetary Policy;
Find related papers by JEL classification:
- E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
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- Hagedorn, Marcus, 2008. "Nominal and real interest rates during an optimal disinflation in New Keynesian models," Working Paper Series 0878, European Central Bank.
- Marcus Hagedorn, 2007. "Nominal and Real Interest Rates during an Optimal Disinflation in New Keynesian Models," IEW - Working Papers 352, Institute for Empirical Research in Economics - University of Zurich.
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