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Liquidity provision, interest rates, and unemployment

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  • Rocheteau, Guillaume
  • Rodriguez-Lopez, Antonio

Abstract

The effective liquidity supply of the economy—the weighted-sum of all assets that serve as media of exchange—matters for interest rates and unemployment. We formalize this idea by adding an over-the-counter market with collateralized trades to the Mortensen–Pissarides model. An increase in public liquidity through a higher supply of real government bonds raises the real interest rate, crowding out private liquidity and increasing unemployment. If unemployment is inefficiently high, keeping liquidity scarce can be socially optimal. A liquidity crisis affecting the acceptability of private assets as collateral widens the rate-of-return difference between private and public liquidity, also increasing unemployment.

Suggested Citation

  • Rocheteau, Guillaume & Rodriguez-Lopez, Antonio, 2014. "Liquidity provision, interest rates, and unemployment," Journal of Monetary Economics, Elsevier, vol. 65(C), pages 80-101.
  • Handle: RePEc:eee:moneco:v:65:y:2014:i:c:p:80-101
    DOI: 10.1016/j.jmoneco.2014.04.006
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    More about this item

    Keywords

    Unemployment; Liquidity; Interest rates;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • 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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