Interest Rates, Moneyness, and the Fisher Equation

Lucas Herrenbrueck ()
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Lucas Herrenbrueck: Simon Fraser University, https://herrenbrueck.weebly.com/

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: The Euler equation of a representative consumer – or its long-run counterpart, the Fisher equation – is at the heart of modern macroeconomics. But it prices a bond – short-term, perfectly safe, yet perfectly illiquid – that does not exist in reality, where most safe assets can be easily traded or pledged as collateral to obtain money, or even for goods and services directly, and their prices reflect their moneyness as much as their dividends. In this paper, we deploy a New Monetarist framework to capture these facts and derive implications for monetary policy and asset pricing. Consistent with the model, we find that the return on a hypothetical illiquid bond, estimated via inflation and consumption growth, behaves very differently from the return on safe and liquid assets. This distinction helps resolve a great number of puzzles associated with the Euler/Fisher equation, and points to a better way of understanding how monetary policy affects the economy

Date: 2023-12
New Economics Papers: this item is included in nep-cba, nep-inv and nep-mon
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