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Persistent Liquidity Effects and Long Run Money Demand

  • Alvarez, Fernando
  • Lippi, Francesco

We present a monetary model in the presence of segmented asset markets that im- plies a persistent fall in interest rates after a once and for all increase in liquidity. The gradual propagation mechanism produced by our model is novel in the literature. We provide an analytical characterization of this mechanism, showing that the magnitude of the liquidity effect on impact, and its persistence, depend on the ratio of two parameters: the long-run interest rate elasticity of money demand and the intertemporal substitution elasticity. At the same time, the model has completely classical long-run predictions, featuring quantity theoretic and Fisherian properties. The model simultaneously explains the short-run "instability" of money demand estimates as-well-as the stability of long-run interest-elastic money demand.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8650.

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Date of creation: Nov 2011
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Handle: RePEc:cpr:ceprdp:8650
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  1. Julia Thomas & Aubhik Khan, 2012. "Inflation and Interest Rates with Endogenous Market Segmentation," 2012 Meeting Papers 1070, Society for Economic Dynamics.
  2. Carlson, John B. & Hoffman, Dennis L. & Keen, Benjamin D. & Rasche, Robert H., 2000. "Results of a study of the stability of cointegrating relations comprised of broad monetary aggregates," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 345-383, October.
  3. Altig, David E & Christiano, Lawrence J. & Eichenbaum, Martin & Lindé, Jesper, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," CEPR Discussion Papers 4858, C.E.P.R. Discussion Papers.
  4. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 1078-1098, October.
  5. Juan Pablo Medina Guzman & Ruy Lama, 2007. "Optimal Monetary Policy in a Small Open Economy Under Segmented Asset Markets and Sticky Prices," IMF Working Papers 07/217, International Monetary Fund.
  6. Darrell Duffie & Bruno Strulovici, 2012. "Capital Mobility and Asset Pricing," Econometrica, Econometric Society, vol. 80(6), pages 2469-2509, November.
  7. Robert J. Hodrick & Narayana Kocherlakota & Deborah Lucas, 1989. "The Variability of Velocity in Cash-In-Advance Models," NBER Working Papers 2891, National Bureau of Economic Research, Inc.
  8. Pedro Teles & Ruilin Zhou, 2005. "A stable money demand: Looking for the right monetary aggregate," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 50-63.
  9. Acharya, Viral V & Shin, Hyun Song & Yorulmazer, Tanju, 2009. "A Theory of Slow-Moving Capital and Contagion," CEPR Discussion Papers 7147, C.E.P.R. Discussion Papers.
  10. Alvarez, Fernando & Lippi, Francesco, 2007. "Financial Innovation and the Transactions Demand for Cash," CEPR Discussion Papers 6472, C.E.P.R. Discussion Papers.
  11. Filippo Occhino, 2004. "Modeling the Response of Money and Interest Rates to Monetary Policy Shocks: A Segmented Markets Approach," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(1), pages 181-197, January.
  12. Vasco Cúrdia & Michael Woodford, 2009. "Credit frictions and optimal monetary policy," BIS Working Papers 278, Bank for International Settlements.
  13. Eric M. Leeper & David B. Gordon, 1991. "In search of the liquidity effect," International Finance Discussion Papers 403, Board of Governors of the Federal Reserve System (U.S.).
  14. Chris Edmond & Pierre-Olivier Weill, 2011. "Aggregate Implications of Micro Asset Market Segmentation," Department of Economics - Working Papers Series 1117, The University of Melbourne.
  15. Amartya Lahiri & Rajesh Singh & Carlos A. Vegh, 2007. "Segmented Asset Markets and Optimal Exchange Rate Regimes," NBER Working Papers 13154, National Bureau of Economic Research, Inc.
  16. John B. Carlson & Benjamin D. Keen, 1996. "MZM: a monetary aggregate for the 1990s?," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 15-23.
  17. Tomoyuki Nakajima, 2006. "Monetary policy with sticky prices and segmented markets," Economic Theory, Springer, vol. 27(1), pages 163-177, 01.
  18. Bilbiie, Florin O., 2008. "Limited asset markets participation, monetary policy and (inverted) aggregate demand logic," Journal of Economic Theory, Elsevier, vol. 140(1), pages 162-196, May.
  19. Julia K. Thomas & Robert G. King, 2007. "Breaking the New Keynesian Dichotomy: Asset Market Segmentation and the Monetary Transmission Mechanism," 2007 Meeting Papers 883, Society for Economic Dynamics.
  20. Thomas J. Sargent & Paolo Surico, 2011. "Two Illustrations of the Quantity Theory of Money: Breakdowns and Revivals," American Economic Review, American Economic Association, vol. 101(1), pages 109-28, February.
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