Working Paper: NBER ID: w17566
Authors: Fernando E. Alvarez; Francesco Lippi
Abstract: We present a monetary model in the presence of segmented asset markets that implies a persistent fall in interest rates after a once and for all increase in liquidity. The gradual propagation mechanism produced by our model is novel in the literature. We provide an analytical characterization of this mechanism, showing that the magnitude of the liquidity effect on impact, and its persistence, depend on the ratio of two parameters: the long-run interest rate elasticity of money demand and the intertemporal substitution elasticity. At the same time, the model has completely classical long-run predictions, featuring quantity theoretic and Fisherian properties. The model simultaneously explains the short-run "instability" of money demand estimates as-well-as the stability of long-run interest-elastic money demand.
Keywords: money demand; liquidity effect; monetary policy; segmented asset markets
JEL Codes: E31; E4; E41; E43; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in money supply (E51) | decrease in interest rates (E43) |
| decrease in interest rates (E43) | liquidity effect (E41) |
| liquidity effect (E41) | wealth redistribution (H23) |
| ratio of interest elasticity of money demand to intertemporal substitution elasticity (E41) | persistence of liquidity effect (E41) |
| velocity (E41) | interest rates (E43) |