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Monetary policy and efficiency in over‐the‐counter financial trade

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  • Athanasios Geromichalos
  • Kuk Mo Jung

Abstract

We develop a monetary model that incorporates over‐the‐counter (OTC) asset trade. After agents have made their money holding decisions, they receive an idiosyncratic shock that affects their valuation for consumption and, hence, for the unique liquid asset, namely money. Subsequently, agents can choose whether they want to enter the OTC market in order to sell assets and thus boost their liquidity or to buy assets and thus provide liquidity to other agents. In our model, inflation affects not only the money holding decisions of agents, as is standard in monetary theory, but also the entry decision of these agents in the financial market. We use our framework to study the effect of inflation on welfare, asset prices and OTC trade volume. In contrast to most monetary models, which predict a negative relationship between inflation and welfare, we find that inflation can be welfare improving within a certain range, because it mitigates a search externality that agents impose on one another when they make their OTC market entry decision. Also, an increase in the holding cost of money will lead to a decrease in asset prices, a regularity that is well documented in the data and often considered anomalous. Politique monétaire et efficacité sur le marché financier de gré à gré. Dans cet article, nous développons un modèle monétaire intégrant la vente d'actifs négociés de gré à gré. Après encaisse, les agents subissent un choc idiosyncratique qui affecte leur appétence pour la consommation et donc pour les actifs liquides, autrement dit l'argent. Consécutivement, les agents peuvent soit décider d'accéder au marché hors cote pour vendre des actifs afin d'accroître leurs liquidités, soit d'acheter des actifs pour fournir des liquidités aux autres agents. Dans notre modèle, et conformément à la théorie monétaire, l'inflation n'affecte pas seulement les décisions des agents en matière d'encaisse, mais aussi leur décision d'accéder au marché financier. Nous utilisons notre propre cadre pour étudier les effets de l'inflation sur le bien‐être, le prix des actifs et le volume des échanges négociés hors marché. Les modèles monétaires établissent pour la plupart une relation négative entre l'inflation et le niveau de bien‐être; néanmoins, et contrairement à ces modèles, nous avons découvert que l'inflation pouvait améliorer le niveau de bien‐être en réduisant la recherche d'externalité que s'imposent les agents entre eux lorsqu'ils intègrent le marché de gré à gré. De même, l'augmentation des coûts liés à la détention de liquidités provoquera une baisse du prix des actifs, un phénomène régulier très bien documenté mais souvent considéré comme anormal.

Suggested Citation

  • Athanasios Geromichalos & Kuk Mo Jung, 2019. "Monetary policy and efficiency in over‐the‐counter financial trade," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 52(4), pages 1699-1754, November.
  • Handle: RePEc:wly:canjec:v:52:y:2019:i:4:p:1699-1754
    DOI: 10.1111/caje.12416
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    Cited by:

    1. Athanasios Geromichalos & Lucas Herrenbrueck & Sukjoon Lee, . "The Strategic Determination of the Supply of Liquid Assets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    2. Seungduck Lee & Kuk Mo Jung, 2020. "A Liquidity‐Based Resolution of the Uncovered Interest Parity Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(6), pages 1397-1433, September.
    3. Han, Han & Julien, Benoît & Petursdottir, Asgerdur & Wang, Liang, 2019. "Asset liquidity and indivisibility," European Economic Review, Elsevier, vol. 119(C), pages 236-250.
    4. Lorenzo Carbonari & Fabrizio Mattesini & Robert J. Waldmann, 2022. "Inflation and Welfare in a Competitive Search Equilibrium with Asymmetric Information," Working Paper series 22-01, Rimini Centre for Economic Analysis.
    5. Geromichalos, Athanasios & Herrenbrueck, Lucas, 2016. "The Strategic Determination of the Supply of Liquid Assets," MPRA Paper 71454, University Library of Munich, Germany.

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    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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