Persistent Liquidity Effects and Long Run Money Demand

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.

The transmission of monetary policy through redistributions and durable purchases

“…7 Examples in this literature are Grossman and Weiss (1983), Rotemberg (1984), and Alvarez and Lippi (2014), who study the role of segmentation in …nancial markets and the redistributive e¤ects caused by monetary policy. Lippi, Ragni, and Trachter (2013) provide a general characterization of optimal monetary policy in a setting with heterogeneous agents and incomplete markets.…”

Long-Run Money Demand in Ghana: In Search of Stability

“…This finding opposes the findings of Nair et al (2008) who concluded that the Asian financial crises had no effect on the stability of money demand in Malaysia. Alvarez & Lippi (2014) provided evidence from a segmented asset market following a one-time increase in liquidity; which implies a continuous fall in interest rates. The study found that the intertemporal substitution and the long-run interest rate elasticities of money demand influenced the magnitude of the liquidity effect.…”

International Evidence on Long-Run Money Demand

“…for some arbitrary value of b * . 2 At this point, we do not want to take a particular stand on where this constraint comes from. Rather, we want to show how the equilibrium money demand relationship is affected by a constraint of this type.…”