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Liquidity, Interest Rates and Output

  • Shouyong Shi

This paper integrates limited participation into monetary search theory to analyze the liquidity effects of open market operations. The centralized bonds market features limited participation and shocks to government bond sales, while the decentralized goods market features bilateral matches. Unmatured bonds can be used together with money to purchase goods in a fraction of matches, but in other matches a legal restriction forbids the use of bonds as the means of payments. In this economy, a shock to bond sales has two distinct liquidity effects. One is the immediate liquidity effect on the bond price and the nominal interest rate. The other is a liquidity effect in the goods market starting one period later, i.e., the effect on the amount of unmatured bonds circulating in the goods market. Thus, even independent shocks can affect the household s money allocation between the two markets, affect real output and the term structure of interest rates, and cause nominal interest rates to be serially correlated. I establish the existence of the equilibrium and, with numerical examples, examine equilibrium properties.

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File URL: http://www.economics.utoronto.ca/public/workingPapers/UT-ECIPA-SHOUYONG-03-06.pdf
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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number shouyong-03-06.

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Length: 30 pages
Date of creation: 11 Jul 2003
Date of revision:
Handle: RePEc:tor:tecipa:shouyong-03-06
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  1. Shouyong Shi, 2002. "Nominal Bonds and Interest Rates: The Case of One-Period Bonds," Working Papers shouyong-03-03, University of Toronto, Department of Economics.
  2. V.V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1995. "Inside money, outside money and short term interest rates," Working Paper Series, Macroeconomic Issues 95-13, Federal Reserve Bank of Chicago.
  3. Stephen Williamson, 2004. "Search, Limited Participation, and Monetary Policy," 2004 Meeting Papers 214, Society for Economic Dynamics.
  4. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  5. Shouyong Shi, 1998. "Search, Inflation, and Capital Accumulation," Working Papers 971, Queen's University, Department of Economics.
  6. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  7. Stephen D. Williamson, 2005. "Monetary Policy and Distribution," 2005 Meeting Papers 379, Society for Economic Dynamics.
  8. 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.
  9. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  10. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
  11. Wallace, Neil, 2001. "Whither Monetary Economics?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 847-69, November.
  12. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  13. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  14. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
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