Interest rates, moneyness, and the Fisher equation
No 1409, 2019 Meeting Papers from Society for Economic Dynamics
The Euler equation of a representative consumer is at the heart of modern macroeconomics. But in empirical applications, it is badly misapplied: it prices a bond that is short-term, perfectly safe, yet perfectly illiquid. Such a bond does not exist. Real-world safe assets are highly tradable or pledgeable as collateral, hence their prices reflect their moneyness as much as their dividends. Indeed, I estimate the return on a hypothetical illiquid bond, for the postwar United States, via inflation and consumption growth, and show that it behaves very differently from the return on safe and liquid assets. I also argue that this distinction helps resolve every puzzle ever associated with the Euler equation (or its long-run counterpart, the Fisher equation), and points to a better way of understanding how monetary policy affects the economy.
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More papers in 2019 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
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