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Liquidity, Interest Rates and Output

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  • Shouyong Shi

Abstract

This paper integrates limited participation into monetary search theory to analyze the liquidity effects of open market operations. The centralized bonds market features limited participation and shocks to government bond sales, while the decentralized goods market features bilateral matches. Unmatured bonds can be used together with money to purchase goods in a fraction of matches, but in other matches a legal restriction forbids the use of bonds as the means of payments. In this economy, a shock to bond sales has two distinct liquidity effects. One is the immediate liquidity effect on the bond price and the nominal interest rate. The other is a liquidity effect in the goods market starting one period later, i.e., the effect on the amount of unmatured bonds circulating in the goods market. Thus, even independent shocks can affect the household s money allocation between the two markets, affect real output and the term structure of interest rates, and cause nominal interest rates to be serially correlated. I establish the existence of the equilibrium and, with numerical examples, examine equilibrium properties.

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Bibliographic Info

Paper provided by University of Toronto, Department of Economics in its series Working Papers with number shouyong-03-06.

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Length: 30 pages
Date of creation: 11 Jul 2003
Date of revision:
Handle: RePEc:tor:tecipa:shouyong-03-06

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Keywords: Liquidity; Interest rates; Money; Search.;

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References

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  1. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  2. Shouyong Shi, 1998. "Search, Inflation, and Capital Accumulation," Working Papers 971, Queen's University, Department of Economics.
  3. V. V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1994. "Inside money, outside money and short-term interest rates," Proceedings, Federal Reserve Bank of Cleveland, pages 1354-1401.
  4. Stephen D. Williamson, 2005. "Monetary Policy and Distribution," 2005 Meeting Papers 379, Society for Economic Dynamics.
  5. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  6. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  7. Shouyong Shi, 2002. "Nominal Bonds and Interest Rates: The Case of One-Period Bonds," Working Papers shouyong-03-03, University of Toronto, Department of Economics.
  8. Wallace, Neil, 2001. "Whither Monetary Economics?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 847-69, November.
  9. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  10. Stephen Williamson, 2004. "Search, Limited Participation, and Monetary Policy," 2004 Meeting Papers 214, Society for Economic Dynamics.
  11. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  12. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  13. Shouyong Shi, 2005. "Nominal Bonds And Interest Rates," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 579-612, 05.
  14. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
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Citations

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Cited by:
  1. Guillaume Rocheteau, 2008. "Money and competing assets under private information," Working Paper 0802, Federal Reserve Bank of Cleveland.
  2. Shouyong Shi, 2006. "A Microfoundation of Monetary Economics," Working Papers tecipa-211, University of Toronto, Department of Economics.
  3. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
  4. Stephen D. Williamson, 2005. "Limited participation and the neutrality of money," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 1-20.
  5. Ed Nosal & Guillaume Rocheteau, 2006. "The economics of payments," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Feb.

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