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Interest Rates, Moneyness, and the Fisher Equation

Lucas Herrenbrueck

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: The Euler equation of a representative consumer - or its long-run counterpart, the Fisher equation - 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 a great number of puzzles associated with the Euler/Fisher equation, and points to a better way of understanding how monetary policy affects the economy.

Keywords: Euler equation; liquid assets; monetary policy; Fisher interest rate (search for similar items in EconPapers)
JEL-codes: E43 E44 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2019-02
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