Interest rates, moneyness, and the Fisher equation

Lucas Herrenbrueck

No 1409, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: 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.

Date: 2019
New Economics Papers: this item is included in nep-dge and nep-his
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Working Paper: Interest Rates, Moneyness, and the Fisher Equation (2019)
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