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Liquidity, Interest Rates and Output

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  • Shouyong Shi

    (University of Toronto
    Central University of Finance and Economics)

Abstract

This paper integrates monetary search theory with limited participation to analyze the liquidity effect of open market operations. The model features a centralized bonds market with limited participation and a decentralized goods market with random matches. In a fraction of matches, buyers can use unmatured bonds together with money to purchase goods. 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, which arises as unmatured bonds facilitate trades. Thus, even independent shocks in the open market can have persistent effects on interest rates and real output. I establish the existence of the equilibrium and, with numerical examples, examine equilibrium properties.

Suggested Citation

  • Shouyong Shi, 2014. "Liquidity, Interest Rates and Output," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 993-1036, November.
  • Handle: RePEc:cuf:journl:y:2014:v:15:i:1:shishouyong
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    References listed on IDEAS

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    1. Stephen D. Williamson, 2006. "Search, Limited Participation, And Monetary Policy ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(1), pages 107-128, February.
    2. 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, May.
    3. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
    4. 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 847-869, November.
    5. Chari, V V & Christiano, Lawrence J & Eichenbaum, Martin, 1995. "Inside Money, Outside Money, and Short-Term Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 1354-1386, November.
    6. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
    7. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
    8. 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.
    9. 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.
    10. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-141, February.
    11. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
    12. 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.
    13. 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.
    14. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
    15. Shi, Shouyong, 1999. "Search, inflation and capital accumulation," Journal of Monetary Economics, Elsevier, vol. 44(1), pages 81-103, August.
    16. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
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    Citations

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    Cited by:

    1. Ed Nosal & Guillaume Rocheteau, 2006. "The economics of payments," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Feb.
    2. Guillaume Rocheteau, 2008. "Money and competing assets under private information," Working Paper 0802, Federal Reserve Bank of Cleveland.
    3. Johnson, Christopher, 2016. "Differences of Opinion, Liquidity, and Monetary Policy," MPRA Paper 70951, University Library of Munich, Germany.
    4. Shouyong Shi, 2006. "A Microfoundation of Monetary Economics," Working Papers tecipa-211, University of Toronto, Department of Economics.
    5. Stephen D. Williamson, 2005. "Limited participation and the neutrality of money," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 1-20.
    6. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
    7. Dominguez, Begona & Gomis-Porqueras, Pedro, 2016. "The Effects of Secondary Markets and Unsecured Credit on Inflation Dynamics," MPRA Paper 75096, University Library of Munich, Germany.
    8. Sylvia Xiao & Randall Wright & Guillaume Rocheteau, 2017. "Open Market Operations," 2017 Meeting Papers 345, Society for Economic Dynamics.

    More about this item

    Keywords

    Liquidity; Interest rates; Money; Search;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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