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Persistent Liquidity Effect and Long Run Money Demand

  • Fernando Alvarez

    (University of Chicago)

  • Francesco Lippi

    (University of Sassari, EIEF)

We present a monetary model in the presence of segmented asset markets that implies 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 Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1017.

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Length: 62 pages
Date of creation: 2010
Date of revision: Oct 2010
Handle: RePEc:eie:wpaper:1017
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  1. Fernando E. Alvarez & Francesco Lippi, 2007. "Financial Innovation and the Transactions Demand for Cash," NBER Working Papers 13416, National Bureau of Economic Research, Inc.
  2. Chris Edmond & Pierre-Olivier Weill, 2011. "Aggregate Implications of Micro Asset Market Segmentation," Department of Economics - Working Papers Series 1117, The University of Melbourne.
  3. 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.
  4. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," NBER Working Papers 11034, National Bureau of Economic Research, Inc.
  5. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research 146, National Bank of Belgium.
  6. 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.
  7. Eric M. Leeper & David B. Gordon, 1991. "In search of the liquidity effect," FRB Atlanta Working Paper 91-17, Federal Reserve Bank of Atlanta.
  8. Ogaki, M & Reinhart, C-M, 1995. "Measuring Intertemporal Substitution : The Role of Durable Goods," RCER Working Papers 404, University of Rochester - Center for Economic Research (RCER).
  9. 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.
  10. Darrell Duffie & Bruno Strulovici, 2012. "Capital Mobility and Asset Pricing," Econometrica, Econometric Society, vol. 80(6), pages 2469-2509, November.
  11. John B. Carlson & Dennis L. Hoffman & Benjamin D. Keen & Robert H. Rasche, 1999. "Results of a study of the stability of cointegrating relations comprised of broad monetary aggregates," Working Paper 9917, Federal Reserve Bank of Cleveland.
  12. 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.
  13. Tomoyuki Nakajima, 2006. "Monetary policy with sticky prices and segmented markets," Economic Theory, Springer, vol. 27(1), pages 163-177, 01.
  14. Julia K. Thomas & Aubhik Khan, 2005. "Inflation and Interest Rates with Endogenous Market Segmentation," 2005 Meeting Papers 170, Society for Economic Dynamics.
  15. 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.
  16. 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.
  17. repec:clu:wpaper:0809-02 is not listed on IDEAS
  18. Florin Bilbiie, 2008. "Limited Asset Market Participation, Monetary Policy and (Inverted) Aggregate Demand Logic," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-00622865, HAL.
  19. 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.
  20. 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.
  21. 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.
  22. 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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