Monetary transaction costs and the term premium

Raphael Espinoza and Dimitrios Tsomocos

Chapter 8 in Financial Regulation and Stability, 2019, pp 224-244 from Edward Elgar Publishing

Abstract: We show that, in a monetary equilibrium, trade and asset prices depend on both the supply of liquidity by the central bank and the liquidity of assets and commodities. Because money demand is a function of the liquidity of assets and commodities, monetary aggregates provide information on trade inefficiencies and are thus instructive for the conduct of monetary policy. We also show that assets that promise higher payoffs in liquidity constrained states in the future are relatively more expensive. This generates a term premium in the yield curve, even in absence of aggregate real uncertainty. The term premium is also higher than what would be calibrated in a representative agent model because monetary costs affect individual agents’ marginal utilities even if aggregate income is unaffected. Our results hold in any monetary economy with heterogeneous agents and short-term liquidity effects, where monetary costs act as transaction costs and the quantity theory of money is verified.

Keywords: Economics and Finance (search for similar items in EconPapers)
Date: 2019
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Related works:
Journal Article: Monetary transaction costs and the term premium (2015)
Working Paper: Monetary Transaction Costs and the Term Premium (2013)
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