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On the Relevance of Open Market Operations

  • Andreas Schabert

This paper reexamines the role of open market operations for short-run effects of monetary policy in a New Keynesian framework. The central bank supplies money in exchange for securities that are discounted with the short-run nominal interest rate, while money demand is induced by a liquidity constraint. We allow for a legal restriction by which only government bonds are eligible. Their supply is bounded by fiscal policy that is assumed to be Ricardian. If public debt is dominated in rate of return by private debt, open market operations matter, and an endogenous liquidity premium and a liquidity effect arise. Nominal interest rate setting (including a peg) is then associated with price level and equilibrium uniqueness, regardless whether prices are flexible or set in a staggered way. Thus, the legal restriction overcomes indeterminacies due to an unbounded money supply, as implied by the real bills doctrine. Moreover, it facilitates constant money growth and interest rate policy to be equivalent

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 272.

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Date of creation: 2004
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Handle: RePEc:red:sed004:272
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  18. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
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