liquidity effects, models of : The New Palgrave Dictionary of Economics

liquidity effects, models of

From The New Palgrave Dictionary of Economics, Second Edition, 2008

Edited by Steven N. Durlauf and Lawrence E. Blume

Abstract

An exogenous increase in the money supply is typically followed by a temporary fall in nominal interest rates. Flexible price macroeconomic models argue that this liquidity effect arises because asset markets are segmented. That is, only a fraction of the agents are present in the bond market when the central bank conducts an open market operation. However, to be quantitatively successful, segmented markets models assume frictions that are too large to be interpreted literally in terms of constraints faced by real-world firms and households. An important open question is: can a complicated array of microeconomic frictions imply one large aggregate friction of this kind?

Keywords

asset market frictions; asset market segmentation; cash-in-advance models; Fisher effect; inflation; inflation expectations; liquidity effects; long-horizon interest rates; monetary transmission mechanism; money supply; nominal interest rates; open-market operations; real business cycle; real interest rates; short-horizon liquidity effects; velocity of circulation

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Edmond, Chris and Pierre-Olivier Weill. "liquidity effects, models of." The New Palgrave Dictionary of Economics. Second Edition. Eds. Steven N. Durlauf and Lawrence E. Blume. Palgrave Macmillan, 2008. The New Palgrave Dictionary of Economics Online. Palgrave Macmillan. 09 February 2010 <http://www.dictionaryofeconomics.com/article?id=pde2008_M000378> doi:10.1057/9780230226203.0979