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Asset prices, liquidity, and monetary policy in the search theory of money

  • Ricardo Lagos

The author presents a search-based model in which money coexists with equity shares on a risky aggregate endowment. Agents can use equity as a means of payment, so shocks to equity prices translate into aggregate liquidity shocks that disrupt the mechanism of exchange. The author characterizes a family of optimal monetary policies and finds that the resulting equity prices are independent of monetary considerations. The author also studies monetary policies that target a constant, but nonzero, nominal interest rate and finds that to the extent that a financial asset is valued as a means to facilitate transactions, the asset's real rate of return will include a liquidity return that depends on monetary considerations. Through this liquidity channel, persistent deviations from an optimal monetary policy can cause the real prices of assets that can be used to relax trading constraints to exhibit persistent deviations from their fundamental values.

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Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2010)
Issue (Month): May ()
Pages: 303-310

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Handle: RePEc:fip:fedlrv:y:2010:i:may:p:303-310:n:v.92no.4
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  1. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  2. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
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