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Welfare improvement from restricting the liquidity of nominal bonds

  • Shouyong Shi

    ()

    (University of Toronto public)

In this paper I examine whether a society can improve welfare by imposing a legal restriction to forbid the use of nominal bonds as a means of payments for goods. To do so, I integrate a microfounded model of money with the framework of limited participation. While the asset market is Walrasian, the goods market is decentralized and the legal restriction is imposed only in a fraction of the trades. I show that the legal restriction can improve the society's welfare. This essential role of the legal restriction persists even in the steady state, in contrast to the one-period role established in the literature. Also in contrast to the literature, the essential role of the legal restriction does not rely on households' ability to trade unmatured bonds for money after observing the taste (or endowment) shocks. Thus, the role cannot be mimicked or replaced with other policies such as discount windows

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File URL: http://www.chass.utoronto.ca/~shouyong/shi1/longbon1.pdf
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File URL: http://repec.org/sed2006/up.7623.1139438182.pdf
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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 245.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:245
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  1. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  2. Hicks, J. R., 1975. "Value and Capital: An Inquiry into some Fundamental Principles of Economic Theory," OUP Catalogue, Oxford University Press, edition 2, number 9780198282693, March.
  3. Boel, Paola & Camera, Gabriele, 2006. "Efficient monetary allocations and the illiquidity of bonds," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1693-1715, October.
  4. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
  5. Miquel Faig, 2006. "Divisible Money In An Economy With Villages," Working Papers tecipa-216, University of Toronto, Department of Economics.
  6. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  7. S. Rao Aiyagari & Neil Wallace & Randall Wright, 1996. "Coexistence of money and interest-bearing securities," Working Papers 550, Federal Reserve Bank of Minneapolis.
  8. Neil Wallace, 1983. "A legal restrictions theory of the demand for "money" and the role of monetary policy," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win.
  9. 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.
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