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Persistent Liquidity Effect and Long Run Money Demand

Author

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  • Fernando Alvarez

    (University of Chicago)

  • Francesco Lippi

    (University of Sassari, EIEF)

Abstract

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.

Suggested Citation

  • Fernando Alvarez & Francesco Lippi, 2010. "Persistent Liquidity Effect and Long Run Money Demand," EIEF Working Papers Series 1017, Einaudi Institute for Economics and Finance (EIEF), revised Oct 2010.
  • Handle: RePEc:eie:wpaper:1017
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    Cited by:

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    2. Benati, Luca & Lucas, Robert E. & Nicolini, Juan Pablo & Weber, Warren, 2021. "International evidence on long-run money demand," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 43-63.
    3. Yulei Peng & Anastasia Zervou, 2014. "Monetary Policy Rules and the Equity Premium," Working Papers 20141115_001, Texas A&M University, Department of Economics.
    4. Florin Bilbiie & Xavier Ragot, 2021. "Optimal Monetary Policy and Liquidity with Heterogeneous Households," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 41, pages 71-95, July.
    5. Luca Gattini & Huw Pill & Ludger Schuknecht, 2015. "A global perspective on inflation and propagation channels," Journal of Banking and Financial Economics, University of Warsaw, Faculty of Management, vol. 1(3), pages 50-76, May.
    6. Sterk, Vincent & Tenreyro, Silvana, 2018. "The transmission of monetary policy through redistributions and durable purchases," Journal of Monetary Economics, Elsevier, vol. 99(C), pages 124-137.
    7. repec:hal:spmain:info:hdl:2441/j75mfllkr89c8aod1nr586ksc is not listed on IDEAS
    8. Tsuruga, Takayuki & Wake, Shota, 2019. "Money-financed fiscal stimulus: The effects of implementation lag," Journal of Economic Dynamics and Control, Elsevier, vol. 104(C), pages 132-151.
    9. Francesco Lippi, 2021. "The Fiscal Arithmetic of a Dual Currency Regime," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(7), pages 1887-1897, October.
    10. Colin Ellis & Haroon Mumtaz & Pawel Zabczyk, 2014. "What Lies Beneath? A Time‐varying FAVAR Model for the UK Transmission Mechanism," Economic Journal, Royal Economic Society, vol. 0(576), pages 668-699, May.
    11. Jaccard, Ivan, 2013. "Liquidity constraints, risk premia, and themacroeconomic effects of liquidity shocks," Working Paper Series 1525, European Central Bank.
    12. Carli, Francesco & Gomis-Porqueras, Pedro, 2021. "Real consequences of open market operations: The role of limited commitment," European Economic Review, Elsevier, vol. 132(C).
    13. Zannini, Ugo, 2020. "The optimal quantity of money and partially-liquid assets," Journal of Economic Theory, Elsevier, vol. 188(C).
    14. Herrenbrueck, Lucas, 2019. "Frictional asset markets and the liquidity channel of monetary policy," Journal of Economic Theory, Elsevier, vol. 181(C), pages 82-120.
    15. Peng, Yulei & Zervou, Anastasia, 2022. "Monetary policy rules and the equity premium in a segmented markets model," Journal of Macroeconomics, Elsevier, vol. 73(C).
    16. Wei Liao & Mr. Sampawende J Tapsoba, 2014. "China’s Monetary Policy and Interest Rate Liberalization: Lessons from International Experiences," IMF Working Papers 2014/075, International Monetary Fund.
    17. repec:hal:wpspec:info:hdl:2441/j75mfllkr89c8aod1nr586ksc is not listed on IDEAS

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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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