Efficient Monetary Allocations and the Illiquidity of Bonds

Paola Boel and Gabriele Camera

Purdue University Economics Working Papers from Purdue University, Department of Economics

Abstract: We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with both money and nominal government bonds, but all trades must be monetized. We demonstrate that a deflationary policy a la Friedman cannot sustain the efficient allocation. The reason is that no-arbitrage imposes a stringent bound on the return money can pay. The efficient allocation can be sustained when bonds have positive yields and under certain conditions only if they are illiquid. Illiquidity meaning bonds cannot be transformed into consumption as efficiently as cash is necessary to eliminate arbitrage opportunities.

Keywords: Money; Heterogeneity; Friedman Rule; Illiquid Assets (search for similar items in EconPapers)
JEL-codes: E4 E5 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2004-11
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-mac and nep-mon
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Journal Article: Efficient monetary allocations and the illiquidity of bonds (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:pur:prukra:1171

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