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Monetary Policy and Efficiency in Over-the-Counter Financial Trade

Author

Listed:
  • Athanasios Geromichalos

    (Department of Economics, University of California, Davis)

  • Kuk Mo Jung

    (Department of Economics, Sogang University, Seoul)

Abstract

We develop a monetary model that incorporates Over-the-Counter (OTC) asset trade. After agents have made their money holding decisions, they receive an idiosyncratic shock that affects their valuation for consumption and, hence, for the unique liquid asset, namely, money. Subse- quently, agents can choose whether they want to enter the OTC market in order to sell assets and, thus, boost their liquidity, or to buy assets and, thus, provide liquidity to other agents. In our model inflation affects not only the money holding decisions of agents, as is standard in monetary theory, but also the entry decision of these agents in the financial market. We use our framework to study the effect of inflation on welfare, asset prices, and OTC trade volume. In contrast to most monetary models, which predict a negative relationship between inflation and welfare, we find that inflation can be welfare improving within a certain range, because it mitigates a search externality that agents impose on one another when they make their OTC market entry decision. Also, an increase in the holding cost of money will lead to a decrease in asset prices, a regularity which is well-documented in the data and often considered anomalous.

Suggested Citation

  • Athanasios Geromichalos & Kuk Mo Jung, 2019. "Monetary Policy and Efficiency in Over-the-Counter Financial Trade," Working Papers 1903, Research Institute for Market Economy, Sogang University.
  • Handle: RePEc:sgo:wpaper:1903
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    References listed on IDEAS

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    Cited by:

    1. Han, Han & Julien, Benoît & Petursdottir, Asgerdur & Wang, Liang, 2019. "Asset liquidity and indivisibility," European Economic Review, Elsevier, vol. 119(C), pages 236-250.
    2. Seungduck Lee & Kuk Mo Jung, 2020. "A Liquidity‐Based Resolution of the Uncovered Interest Parity Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(6), pages 1397-1433, September.

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    More about this item

    Keywords

    monetary-search models; liquidity; asset prices; over-the-counter markets;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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