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The Liquidity-Augmented Model of Macroeconomic Aggregates

Athanasios Geromichalos () and Lucas Herrenbrueck
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Athanasios Geromichalos: University of California – Davis

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: We propose a new model of the macroeconomy which is simple and tractable, yet explicit about the foundations of liquidity. Monetary policy is implemented via swaps of money for liquid bonds in a secondary asset market, and these have real effects because money, bonds, and capital are imperfect substitutes. The model unifies two classical channels through which the price of liquidity affects the economy (Friedman’s real balance effect vs Mundell’s and Tobin’s asset substitution effect), and it shines light on important macroeconomic questions: optimal monetary policy in the long run, the causal link between interest rates and inflation, and the existence and persistence of a liquidity trap where interest rates are zero but inflation is positive.

Keywords: monetary theory; monetary policy; financial frictions; liquidity trap (search for similar items in EconPapers)
JEL-codes: E31 E43 E44 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
Date: 2017-10
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