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Efficiency Improvement from Restricting the Liquidity of Nominal Bonds

  • Shouyong Shi

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.

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File URL: https://www.economics.utoronto.ca/public/workingPapers/tecipa-329.pdf
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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-329.

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Length: 39 pages
Date of creation: 12 Aug 2008
Date of revision:
Handle: RePEc:tor:tecipa:tecipa-329
Contact details of provider: Postal: 150 St. George Street, Toronto, Ontario
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  1. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  2. 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.
  3. Bryant, John & Wallace, Neil, 1984. "A Price Discrimination Analysis of Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 51(2), pages 279-88, April.
  4. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  5. Berentsen, Aleksander & Camera, Gabriele & Waller, Christopher, 2007. "Money, credit and banking," Journal of Economic Theory, Elsevier, vol. 135(1), pages 171-195, July.
  6. 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.
  7. Williamson, Stephen D., 2008. "Monetary policy and distribution," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1038-1053, September.
  8. 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.
  9. S. Rao Aiyagari & Neil Wallace & Randall Wright, 1996. "Coexistence of money and interest-bearing securities," Working Papers 550, Federal Reserve Bank of Minneapolis.
  10. 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.
  11. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, . "Friedman Meets Hosios: Efficiency in Search Models of Money," IEW - Working Papers 154, Institute for Empirical Research in Economics - University of Zurich.
  12. 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.
  13. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  14. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  15. Narayana Kocherlakota, 2003. "Societal Benefits of Illiquid Bonds," Levine's Working Paper Archive 506439000000000300, David K. Levine.
  16. 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.
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