A Tractable Model of Indirect Asset Liquidity

Assets have “indirect liquidity” if they cannot be used as media of exchange, but can be traded to obtain a medium of exchange (money) and thereby inherit monetary properties. This essay describes a simple dynamic model of indirect asset liquidity, provides closed form solutions for real and nominal assets, and discusses properties of the solutions. Some of these are standard: assets and money are imperfect substitutes, asset demand curves slope down, and money is not always neutral. Other properties are more surprising: prices are flexible but appear sticky, and an increase in the supply of indirectly liquid assets can decrease welfare. Because of its simplicity, the model can be useful as a building block inside a larger model, and for teaching concepts from monetary theory

A Tractable Model of Indirect Asset Liquidity

Assets have “indirect liquidity” if they cannot be used as media of exchange, but can be traded to obtain a medium of exchange (money) and thereby inherit monetary properties. This essay describes a simple dynamic model of indirect asset liquidity, provides closed form solutions for real and nominal assets, and discusses properties of the solutions. Some of these are standard: assets are imperfect substitutes, asset demand curves slope down, and money is not always neutral. Other properties are more surprising: prices are flexible but appear sticky, and an increase in the supply of indirectly liquid assets can decrease welfare. Because of its simplicity, the model can be useful as a building block inside a larger model, and for teaching concepts from monetary theory

A Tractable Model of Indirect Asset Liquidity

Assets have “indirect liquidity” if they cannot be used as media of exchange, but can be traded to obtain a medium of exchange (money) and thereby inherit monetary properties. This essay describes a simple dynamic model of indirect asset liquidity, provides closed form solutions for real and nominal assets, and discusses properties of the solutions. Some of these are standard: assets are imperfect substitutes, asset demand curves slope down, and money is not always neutral. Other properties are more surprising: prices are flexible but appear sticky, and an increase in the supply of indirectly liquid assets can decrease welfare. Because of its simplicity, the model can be useful as a building block inside a larger model, and for teaching concepts from monetary theory

Inside Money, Investment, and Unconventional Monetary Policy

I develop a model where banks play a central role in monetary policy transmission. By credibly committing to repayment, banks can perform liquidity transformation. Illiquid assets may pay a liquidity premium because they allow banks to create liquid assets. The policy analysis discusses how the monetary authority can affect nominal rates and inflation when the fiscal authority follows nominal or real debt targets. A main result is that under a nominal debt target, the monetary authority is only able to increase inflation at the zero-lower bound by issuing money via lump-sum transfers, while doing so via bond purchases is ineffective

The Strategic Determination of the Supply of Liquid Assets

We study how the strategic interaction of liquid-asset suppliers depends on the financial market conditions that determine asset liquidity. In our model, two asset suppliers try to profit from the liquidity services their assets confer. Asset liquidity is indirect in the sense that assets can be sold for money in over-the-counter (OTC) secondary markets. These secondary markets are segmented and customers will be drawn to the market where they expect to find the best terms. Understanding this, asset-suppliers play a differentiated Cournot game, where product differentiation here stems from differences in OTC microstructure. We find that small differences in OTC microstructure can induce very large differences in the relative liquidity of two assets. Asset demand curves can slope upward for even modest degrees of increasing returns in the matching technology. And if one asset supplier has an exogenous advantage over another, the favored agent may want to strategically increase asset supply for the purpose of driving competitors out of the secondary market altogether

Quantitative Easing and the Liquidity Channel of Monetary Policy

How do central bank purchases of illiquid assets affect interest rates and the real economy? In order to answer this question, I construct a parsimonious and very flexible general equilibrium model of asset liquidity. In the model, households are heterogeneous in their asset portfolios and demand for liquidity, and asset trade is subject to frictions. I find that open market purchases of illiquid assets are fundamentally different from helicopter drops: asset purchases stimulate private demand for consumption goods at the expense of demand for assets and investment goods, while helicopter drops do the reverse. A temporary program of quantitative easing can therefore cause a 'hangover' of elevated yields and depressed investment after it has ended. When assets are already scarce, further purchases can crowd out the private flow of funds and cause high real yields and disinflation, resembling a liquidity trap. In the long term, lowering the stock of government debt reduces the supply of liquidity but increases the capital-output ratio. The consequences for output are ambiguous in theory but a calibration to US data suggests that the liquidity effect dominates; in other words, the supply of Treasuries is 'too small'

Liquidity Premium, Credit Costs, and Optimal Monetary Policy

I study how monetary policy affects firms' external financing decisions. More precisely, I study the transmission mechanism of monetary policy to credit costs in a general equilibrium macroeconomic model where firms issue corporate bonds or obtain bank loans, and corporate bonds are not just stores of value but also serve a liquidity role. The model shows that an increase in the nominal policy rate can lower the borrowing cost in the corporate bond market, while increasing that in the bank loan market, and I provide empirical evidence that supports this result. The model also predicts that a higher nominal policy rate induces firms to substitute corporate bonds for bank loans, which is supported by the existing empirical evidence. In the model, the Friedman rule is suboptimal so that keeping the cost of holding liquidity at a positive level is socially optimal. The optimal policy rate is an increasing function of the degree of corporate bond liquidity