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Liquidity, Inflation, and Monetary Policy

Author

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  • Marcus Hagedorn

    () (Department of Economics University of Bonn)

Abstract

In standard monetary models nominal interest rates should be decreased in response to a switch to a lower inflation target. This paper considers this interaction between inflation and nominal interest rates in a dynamic model of liquidity. In a repeated Diamond&Dybvig economy a financial intermediation sector provides those agents with money/liquidity who urgently need it and saves for those who do not. I show when a lower inflation target requires a higher nominal interest rate. I then calibrate the model. The model fits the data very well and the response of inflation to a permanent increase in nominal interest rates is negative if nominal interest rates are low (`the market is liquid') and positive if nominal interest rates are high (`the market is illiquid')

Suggested Citation

  • Marcus Hagedorn, 2006. "Liquidity, Inflation, and Monetary Policy," 2006 Meeting Papers 677, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:677
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    Cited by:

    1. Hagedorn, Marcus, 2008. "Nominal and real interest rates during an optimal disinflation in New Keynesian models," Working Paper Series 878, European Central Bank.
    2. Marcus Hagedorn, 2007. "Nominal and Real Interest Rates during an Optimal Disinflation in New Keynesian Models," IEW - Working Papers 352, Institute for Empirical Research in Economics - University of Zurich.

    More about this item

    Keywords

    Liquidity; Monetary Policy;

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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