Intertemporal Substitution and the Liquidity Effect in a Sticky Price Model

Javier Andrés (), David Lopez-Salido and Javier Valles

No 1698, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: The liquidity effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper seeks to understand under what conditions such an effect can be explained in a general equilibrium model with sticky prices and capital adjustment costs. The paper first confirms that, with separable preferences, a low degree of intertemporal substitution in consumption is a necessary condition for the existence of the liquidity effect. Contrary to this result, in a model with non-separable preferences and capital accumulation it takes an implausibly high degree of intertemporal substitution to produce a liquidity effect. The robustness of these results to alternative degrees of nominal rigidities, money demand properties and real rigidities is also analyzed.

Date: 2000-08-01
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Related works:
Journal Article: Intertemporal substitution and the liquidity effect in a sticky price model (2002)
Working Paper: Intertemporal Substitution and the Liquidity Effect in a Sticky Price Model (1999)
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