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Liquidity, Interest Rates and Output

  • Shouyong Shi

This paper integrates monetary search theory with limited participation to analyze the liquidity effect of open market operations. The model features a centralized bonds market with limited participation and a decentralized goods market with random matches. In a fraction of matches, buyers can use unmatured bonds together with money to purchase goods. In other matches, a legal restriction forbids the use of bonds as the means of payments. In this economy, a shock to bond sales has two distinct liquidity effects. One is the immediate liquidity effect on the bond price and the nominal interest rate. The other is a liquidity effect in the goods market starting one period later, which arises as unmatured bonds facilitate trades. Thus, even independent shocks in the open market can have persistent effects on interest rates and real output. I establish the existence of the equilibrium and, with numerical examples, examine equilibrium properties.

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Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 666156000000000250.

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Date of creation: 01 Sep 2003
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Handle: RePEc:cla:levrem:666156000000000250
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  1. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
  2. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  3. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  4. Shouyong Shi, 1998. "Search, Inflation, and Capital Accumulation," Working Papers 971, Queen's University, Department of Economics.
  5. Shouyong Shi, 2002. "Nominal Bonds and Interest Rates: The Case of One-Period Bonds," Working Papers shouyong-03-03, University of Toronto, Department of Economics.
  6. V.V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1995. "Inside money, outside money and short term interest rates," Working Paper Series, Macroeconomic Issues 95-13, Federal Reserve Bank of Chicago.
  7. Stephen Williamson, 2004. "Search, Limited Participation, and Monetary Policy," 2004 Meeting Papers 214, Society for Economic Dynamics.
  8. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  9. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
  10. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, September.
  11. Shouyong Shi, 2005. "Nominal Bonds And Interest Rates," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 579-612, 05.
  12. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  13. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  14. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  15. Wallace, Neil, 2001. "Whither Monetary Economics?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 847-69, November.
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