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Asset Prices, Liquidity, and Monetary Policy in an Exchange Economy

  • Ricardo Lagos

I formulate a search-based asset-pricing model where equity shares and fiat money can be used as means of payment. I characterize a family of optimal stochastic monetary policies. Every policy in this family implements Friedman's prescription of zero nominal interest rates. Under an optimal policy, equity prices and returns are independent of monetary considerations. I also study a perturbation of the family of optimal policies that targets a constant but nonzero nominal interest rate. Under such policies, the average real return on equity is negatively correlated with the average inflation rate.

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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 390.

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Date of creation: 2009
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Handle: RePEc:red:sed009:390
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
  2. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  3. Danthine, Jean-Pierre & Donaldson, John B, 1986. "Inflation and Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 54(3), pages 585-605, May.
  4. Townsend, Robert M., 1987. "Asset-return anomalies in a monetary economy," Journal of Economic Theory, Elsevier, vol. 41(2), pages 219-247, April.
  5. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  6. Bohn, Henning, 1991. "On Cash-in-Advance Models of Money Demand and Asset Pricing," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 224-42, May.
  7. Alberto Giovannini & Pamela Labadie, 1989. "Asset Prices and Interest Rates in Cash-In-Advance Models," NBER Working Papers 3109, National Bureau of Economic Research, Inc.
  8. Kaul, Gautam, 1987. "Stock returns and inflation : The role of the monetary sector," Journal of Financial Economics, Elsevier, vol. 18(2), pages 253-276, June.
  9. Marshall, David A, 1992. " Inflation and Asset Returns in a Monetary Economy," Journal of Finance, American Finance Association, vol. 47(4), pages 1315-42, September.
  10. Nelson, Charles R, 1976. "Inflation and Rates of Return on Common Stocks," Journal of Finance, American Finance Association, vol. 31(2), pages 471-83, May.
  11. Boudoukh, Jacob & Richardson, Matthew, 1993. "Stock Returns and Inflation: A Long-Horizon Perspective," American Economic Review, American Economic Association, vol. 83(5), pages 1346-55, December.
  12. Ricardo Lagos & Guillaume Rocheteau, 2004. "Money and capital as competing media of exchange," Staff Report 341, Federal Reserve Bank of Minneapolis.
  13. B. Ravikumar & Enchuan Shao, 2005. "Search Frictions and Asset Price Volatility," 2005 Meeting Papers 227, Society for Economic Dynamics.
  14. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  15. Gultekin, N Bulent, 1983. " Stock Market Returns and Inflation: Evidence from Other Countries," Journal of Finance, American Finance Association, vol. 38(1), pages 49-65, March.
  16. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-65, September.
  17. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  18. Balduzzi, Pierluigi, 1996. "Inflation and asset prices in a monetary economy," Economics Letters, Elsevier, vol. 53(1), pages 67-74, October.
  19. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
  20. Bodie, Zvi, 1976. "Common Stocks as a Hedge against Inflation," Journal of Finance, American Finance Association, vol. 31(2), pages 459-70, May.
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