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Efficiency Improvement from Restricting the Liquidity of Nominal Bonds

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  • Shouyong Shi

Abstract

This paper addresses why it is beneficial for a society to restrict the use of nominal bonds as a means of payment for goods. The model has a centralized asset market and a decentralized goods market. Individuals face matching shocks that affect the marginal utility of consumption, but they cannot insure, borrow or trade assets against such risks. The government imposes a legal restriction to prohibit nominal bonds from being used as a means of payment in a subset of trades. I show that this partial legal restriction can improve the society's welfare. In contrast to the literature, the efficiency role of the restriction exists in the steady state and it does not require the households to be able to trade assets after receiving the shocks. Moreover, even when lump-sum taxes are available, the efficiency role continues to exist under a condition that induces optimal money growth to be above the Friedman rule.

Suggested Citation

  • Shouyong Shi, 2008. "Efficiency Improvement from Restricting the Liquidity of Nominal Bonds," Working Papers tecipa-329, University of Toronto, Department of Economics.
  • Handle: RePEc:tor:tecipa:tecipa-329
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    References listed on IDEAS

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    1. 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, May.
    2. Kocherlakota, Narayana R., 2003. "Societal benefits of illiquid bonds," Journal of Economic Theory, Elsevier, vol. 108(2), pages 179-193, February.
    3. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
    4. Rao Aiyagari, S. & Wallace, Neil & Wright, Randall, 1996. "Coexistence of money and interest-bearing securities," Journal of Monetary Economics, Elsevier, vol. 37(3), pages 397-419, June.
    5. 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.
    6. 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.
    7. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, 2007. "Friedman Meets Hosios: Efficiency in Search Models of Money," Economic Journal, Royal Economic Society, vol. 117(516), pages 174-195, January.
    8. Ritter Moritz, 2010. "The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-26, June.
    9. Shouyong Shi, 2001. "Liquidity, Bargaining, and Multiple Equilibria in a Search Monetary Model," Annals of Economics and Finance, Society for AEF, vol. 2(2), pages 325-351, November.
    10. John Bryant & Neil Wallace, 1984. "A Price Discrimination Analysis of Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 51(2), pages 279-288.
    11. Berentsen, Aleksander & Camera, Gabriele & Waller, Christopher, 2007. "Money, credit and banking," Journal of Economic Theory, Elsevier, vol. 135(1), pages 171-195, July.
    12. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
    13. Temzelides, Ted & Williamson, Stephen D., 2001. "Payments Systems Design in Deterministic and Private Information Environments," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 297-326, July.
    14. 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.
    15. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
    16. Arthur J. Hosios, 1990. "On The Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 279-298.
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    Citations

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    Cited by:

    1. Andolfatto, David & Martin, Fernando M. & Zhang, Shengxing, 2017. "Rehypothecation and liquidity," European Economic Review, Elsevier, vol. 100(C), pages 488-505.
    2. Berentsen, Aleksander & Waller, Christopher, 2011. "Outside versus inside bonds: A ModiglianiâMiller type result for liquidity constrained economies," Journal of Economic Theory, Elsevier, vol. 146(5), pages 1852-1887, September.
    3. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2014. "Floor Systems for Implementing Monetary Policy: Some Unpleasant Fiscal Arithmetic," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 523-542, July.
    4. David Andolfatto, 2009. "On the Societal Benefits of Illiquid Bonds," Working Paper series 13_09, Rimini Centre for Economic Analysis.
    5. repec:eee:dyncon:v:79:y:2017:i:c:p:184-200 is not listed on IDEAS
    6. Hu, Tai-Wei & Rocheteau, Guillaume, 2013. "On the coexistence of money and higher-return assets and its social role," Journal of Economic Theory, Elsevier, vol. 148(6), pages 2520-2560.
    7. Huber, Samuel & Kim, Jaehong, 2017. "On the optimal quantity of liquid bonds," Journal of Economic Dynamics and Control, Elsevier, vol. 79(C), pages 184-200.
    8. Waller, Christopher J., 2015. "Microfoundations of Money: Why They Matter," Review, Federal Reserve Bank of St. Louis, vol. 97(4), pages 289-301.
    9. Yiting Li & Guillaume Rocheteau & Pierre-Olivier Weill, 2012. "Liquidity and the Threat of Fraudulent Assets," Journal of Political Economy, University of Chicago Press, vol. 120(5), pages 000.
    10. Aleksander Berentsen & Alessandro Marchesiani & Christopher J. Waller, 2010. "Channel systems: why is there a positive spread?," IEW - Working Papers 517, Institute for Empirical Research in Economics - University of Zurich.
    11. Aleksander Berentsen & Samuel Huber & Alessandro Marchesiani, 2014. "Degreasing The Wheels Of Finance," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 55, pages 735-763, August.
    12. Mahmoudi, Babak, 2013. "Open-Market Operations, Asset Distributions, and Endogenous Market Segmentation," MPRA Paper 50089, University Library of Munich, Germany.
    13. Mahmoudi, Babak, 2013. "Liquidity Effects of Central Banks' Asset Purchase Programs," MPRA Paper 49424, University Library of Munich, Germany.

    More about this item

    Keywords

    Nominal Bonds; Money; Efficiency; Return dominance;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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