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Intertemporal substitution and the liquidity effect in a sticky price model

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  • Andres, Javier
  • David Lopez-Salido, J.
  • Valles, Javier

Abstract

The liquidity effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper seeks to understand under what conditions such an effect can be explained in a general equilibrium model with sticky prices and capital adjustment costs. The paper first confirms that, with separable preferences, a low degree of intertemporal substitution in consumption is a necessary condition for the existence of the liquidity effect. Contrary to this result, in a model with non-separable preferences and capital accumulation it takes an implausibly high degree of intertemporal substitution to produce a liquidity effect. The robustness of these results to alternative degrees of nominal rigidities, money demand properties and real rigidities is also analyzed.
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Suggested Citation

  • Andres, Javier & David Lopez-Salido, J. & Valles, Javier, 2002. "Intertemporal substitution and the liquidity effect in a sticky price model," European Economic Review, Elsevier, vol. 46(8), pages 1399-1421, September.
  • Handle: RePEc:eee:eecrev:v:46:y:2002:i:8:p:1399-1421
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    Cited by:

    1. Piti Disyatat, 2008. "Monetary policy implementation: Misconceptions and their consequences," BIS Working Papers 269, Bank for International Settlements.
    2. Auray, Stephane & de Blas, Beatriz, 2007. "On Stickiness, Cash in Advance, and Persistence," Working Papers in Economic Theory 2007/05, Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History).
    3. Andreas Schabert, 2004. "On the relevance of open market operations for the short-run effects of monetary policy," Money Macro and Finance (MMF) Research Group Conference 2003 83, Money Macro and Finance Research Group.
    4. Gali, Jordi & Lopez-Salido, J. David & Valles, Javier, 2003. "Technology shocks and monetary policy: assessing the Fed's performance," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 723-743, May.
    5. Ka Wai Terence Fung & Chi Keung Marco Lau & Kwok Ho Chan, 2016. "An R&D-based real business cycle model," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 63(4), pages 327-358, December.
    6. Galí, Jordi, 2002. "New Perspectives on Monetary Policy, Inflation and the Business Cycle," CEPR Discussion Papers 3210, C.E.P.R. Discussion Papers.
    7. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, vol. 33(C), pages 620-630.
    8. Giammarioli, Nicola & Valla, Natacha, 2003. "The natural real rate of interest in the euro area," Working Paper Series 233, European Central Bank.
    9. Edge, Rochelle M., 2007. "Time-to-build, time-to-plan, habit-persistence, and the liquidity effect," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1644-1669, September.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General

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