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Liquidity, Interest Rates and Output

  • Shouyong Shi

    (University of Toronto
    Central University of Finance and Economics)

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.

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Article provided by Society for AEF in its journal Annals of Economics and Finance.

Volume (Year): 15 (2014)
Issue (Month): 2 (November)
Pages: 993-1036

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Handle: RePEc:cuf:journl:y:2014:v:15:i:1:shishouyong
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  1. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers 916, Queen's University, Department of Economics.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc.
  3. V.V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1995. "Inside money, outside money and short term interest rates," Working Paper Series, Macroeconomic Issues 95-13, Federal Reserve Bank of Chicago.
  4. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  5. Shouyong Shi, 1998. "Search, Inflation, and Capital Accumulation," Working Papers 971, Queen's University, Department of Economics.
  6. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  7. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  8. 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.
  9. 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.
  10. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
  11. 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.
  12. Stephen Williamson, 2004. "Search, Limited Participation, and Monetary Policy," 2004 Meeting Papers 214, Society for Economic Dynamics.
  13. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  14. 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.
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