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Money, interest rates, and exchange rates with endogenously segmented asset markets

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Author Info
Fernando Alvarez
Andrew Atkeson
Patrick J. Kehoe

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Abstract

This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a Baumol-Tobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents’ consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 605.

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Date of creation: 2000
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Handle: RePEc:fip:fedmwp:605

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Keywords: Money Interest rates Liquidity (Economics)

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  3. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November. [Downloadable!] (restricted)
  4. Chatterjee, Satyajit & Corbae, Dean, 1992. "Endogenous Market Participation and the General Equilibrium Value of Money," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 615-46, June. [Downloadable!] (restricted)
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  5. Basak, Suleyman & Cuoco, Domenico, 1998. "An Equilibrium Model with Restricted Stock Market Participation," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(2), pages 309-41.
  6. Evans, Charles L. & Marshall, David A., 1998. "Monetary policy and the term structure of nominal interest rates: Evidence and theory," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 53-111, December. [Downloadable!] (restricted)
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  7. Romer, David, 1986. "A Simple General Equilibrium Version of the Baumol-Tobin Model," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 663-85, November. [Downloadable!] (restricted)
  8. Allen, Franklin & Gale, Douglas, 1994. "Limited Market Participation and Volatility of Asset Prices," American Economic Review, American Economic Association, vol. 84(4), pages 933-55, September. [Downloadable!] (restricted)
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  9. Schlagenhauf, Don E. & Wrase, Jeffrey M., 1995. "Liquidity and real activity in a simple open economy model," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 431-461, June. [Downloadable!] (restricted)
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  10. Jovanovic, Boyan, 1982. "Inflation and Welfare in the Steady State," Journal of Political Economy, University of Chicago Press, vol. 90(3), pages 561-77, June. [Downloadable!] (restricted)
  11. Balasko, Yves & Cass, David & Shell, Karl, 1995. "Market Participation and Sunspot Equilibria," Review of Economic Studies, Blackwell Publishing, vol. 62(3), pages 491-512, July. [Downloadable!] (restricted)
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  12. Pennacchi, George G, 1991. "Identifying the Dynamics of Real Interest Rates and Inflation: Evidence Using Survey Data," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 4(1), pages 53-86. [Downloadable!] (restricted)
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  14. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  15. Aiyagari, S. Rao & Gertler, Mark, 1991. "Asset returns with transactions costs and uninsured individual risk," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 311-331, June. [Downloadable!] (restricted)
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  18. Grilli, Vittorio & Roubini, Nouriel, 1992. "Liquidity and exchange rates," Journal of International Economics, Elsevier, vol. 32(3-4), pages 339-352, May. [Downloadable!] (restricted)
  19. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November. [Downloadable!] (restricted)
  20. Mussa, Michael, 1986. "Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 117-214, January. [Downloadable!] (restricted)
  21. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report 223, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  22. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December. [Downloadable!] (restricted)
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  24. Alvarez, Fernando & Atkeson, Andrew, 1997. "Money and exchange rates in the Grossman-Weiss-Rotemberg model," Journal of Monetary Economics, Elsevier, vol. 40(3), pages 619-640, December. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Fernando Alvarez & Robert E. Lucas, Jr. & Warren E. Weber, 2001. "Interest rates and inflation," Working Papers 609, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  2. Russell Cooper & Hubert Kempf, 2002. "Overturning Mundell: fiscal policy in a monetary union," Staff Report 311, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  3. Jonathan A. Parker & Christian Julliard, 2003. "Consumption Risk and Cross-Sectional Returns," NBER Working Papers 9538, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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