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Outside versus inside bonds: A Modigliani-Miller type result for liquidity constrained economies

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  • Aleksander Berentsen
  • Christopher Waller

Abstract

When agents are liquidity constrained, two options exist — sell assets or borrow. We compare the allocations arising in two economies: in one, agents can sell government bonds (outside bonds) and in the other they can borrow (issue inside bonds). All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds but that the converse is not true. However, the optimal policy in each economy makes the allocations equivalent.

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Bibliographic Info

Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 443.

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Date of creation: Sep 2009
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Handle: RePEc:zur:iewwpx:443

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Keywords: Liquidity; financial markets; monetary policy; search;

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References

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  1. Aleksander Berentsen & Gabriele Camera & Christopher Waller, . "The Distribution of Money Balances and the Non-Neutrality of Money," IEW - Working Papers 220, Institute for Empirical Research in Economics - University of Zurich.
  2. Guillaume Rocheteau & Randall Wright, 2005. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Econometrica, Econometric Society, vol. 73(1), pages 175-202, 01.
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  9. Aleksander Berentsen & Gabriele Camera & Christopher Waller, . "Money, Credit and Banking," IEW - Working Papers 219, Institute for Empirical Research in Economics - University of Zurich.
  10. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-98, May.
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Cited by:
  1. Williamson, Stephen & Wright, Randall, 2010. "New Monetarist Economics: Models," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 2, pages 25-96 Elsevier.
  2. Aleksander Berentsen & Samuel Huber & Alessandro Marchesiani, 2011. "Free-riding on liquidity," ECON - Working Papers 032, Department of Economics - University of Zurich.
  3. Athanasios Geromichalos & Lucas Herrenbrueck, 2012. "Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets," Working Papers 1220, University of California, Davis, Department of Economics.

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