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Real consequences of open market operations: The role of limited commitment

Francesco Carli and Pedro Gomis-Porqueras

European Economic Review, 2021, vol. 132, issue C

Abstract: We study how limited commitment in credit markets affects the implementation of open market operations and characterize when they result in real indeterminacies and when they have real effects. To do so, we consider a frictional and incomplete market framework where agents face stochastic trading opportunities and limited commitment. We find necessary and sufficient conditions for the existence of a unique stationary monetary equilibrium when limited commitment does not restrict agent’s choices. However, real indeterminacies are possible when buyers face a binding no-default constraint. When the endogenous borrowing limit binds and bonds are not priced fundamentally, open market operations generically have real effects. A sale of government bonds can increase or decrease interest rates, depending on the nature of the equilibria. These phenomena are consistent with what is observed in the US. Moreover, when multiple equilibria exists welfare is larger at the steady state with a lower liquidity premium on government debt. Finally, government bond purchases can be used to rule out real indeterminacies, thus finding another rationale for such policy.

Keywords: Taxes; Inflation; Liquidity premium (search for similar items in EconPapers)
JEL-codes: E40 E61 E62 H21 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.euroecorev.2020.103639

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