Frictional asset markets and the liquidity channel of monetary policy

How do central bank purchases of illiquid assets affect asset prices and the real economy? To answer this question, I construct a model with heterogeneous households – some households need money more urgently than others and thus hold more of it. Households (and the government) can trade in frictional asset markets. I find that open market purchases are fundamentally different from helicopter drops: asset purchases stimulate private demand for consumption goods at the expense of demand for assets, while helicopter drops do the reverse. When assets are already scarce, further purchases crowd out the private flow of funds and can cause high real yields and disinflation – a liquidity trap.