Liquidity, Inflation, and Monetary Policy

Marcus Hagedorn

No 677, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: In standard monetary models nominal interest rates should be decreased in response to a switch to a lower inflation target. This paper considers this interaction between inflation and nominal interest rates in a dynamic model of liquidity. In a repeated Diamond&Dybvig economy a financial intermediation sector provides those agents with money/liquidity who urgently need it and saves for those who do not. I show when a lower inflation target requires a higher nominal interest rate. I then calibrate the model. The model fits the data very well and the response of inflation to a permanent increase in nominal interest rates is negative if nominal interest rates are low (`the market is liquid') and positive if nominal interest rates are high (`the market is illiquid')

Keywords: Liquidity; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E41 E44 E52 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed006:677

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