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Persistent Liquidity Effect and Long Run Money Demand

Fernando Alvarez and Francesco Lippi
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Fernando Alvarez: University of Chicago

No 1017, EIEF Working Papers Series from Einaudi Institute for Economics and Finance (EIEF)

Abstract: We present a monetary model in the presence of segmented asset markets that implies a persistent fall in interest rates after a once and for all increase in liquidity. The gradual propagation mechanism produced by our model is novel in the literature. We provide an analytical characterization of this mechanism, showing that the magnitude of the liquidity effect on impact, and its persistence, depend on the ratio of two parameters: the long-run interest rate elasticity of money demand and the intertemporal substitution elasticity. At the same time, the model has completely classical long-run predictions, featuring quantity theoretic and Fisherian properties. The model simultaneously explains the short-run “instability” of money demand estimates as-well-as the stability of long-run interest-elastic money demand.

Date: 2010, Revised 2010-10
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Related works:
Journal Article: Persistent Liquidity Effects and Long-Run Money Demand (2014) Downloads
Working Paper: Persistent Liquidity Effects and Long Run Money Demand (2011) Downloads
Working Paper: Persistent Liquidity Effects and Long Run Money Demand (2011) Downloads
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