Liquidity Risk and Banks’ Asset Composition: Implications for Monetary Policy

monstrate that in?ation adversely a¤ects capital formation through the crowding out e¤ect. Interestingly, the results are at odds with empirical evidence. In particular, recent studies point out to an asymmetric rela- tionship between in?ation and the real economy across countries. Speci?- cally, in?ation and output are negatively correlated in poor countries. In contrast, in?ation is associated with higher levels of economic activity in advanced economies. I present a monetary growth model where the ex- posure to risk is inversely related to the level of income. In this setting, I demonstrate that the e¤ects of monetary policy depend on the level of economic activity and the portfolio composition of ?nancial institutions. In poor countries, banks?portfolios consist primarily of government liabili- ties. Therefore, a higher rate of money creation inhibits capital formation in these economies. In contrast, banks devote more resources towards productive uses in advanced countries. Consequently, monetary policy generates a Tobin effect.Economic Development, Banks, Monetary Policy

THE COST OF CAPITAL, ASSET PRICES AND THE AFFECTS OF MONETARY POLICY

The primary objective of this paper is to study the interaction between mon- etary policy, asset prices, and the sources of technological progress. We develop a two sector model in which ?nancial institutions promote risk sharing and ?at money alleviates trade frictions. Since the price of capital goods depends on in- ?ation, the Friedman Rule may be sub-optimal. In addition, di¤erent sources of productivity can a¤ect the degree of risk sharing. Although the optimal money growth rate falls in response to an increase in productivity in either sector of the economy, monetary policy should react more aggressively to investment-speci?c productivity. Our results are broadly consistent with U.S. monetary policy dur- ing the postwar period.Asset Prices, Investment, Monetary Policy

The Stock Market, Monetary Policy, and Economic Development

In this paper, we examine the impact of financial market development on capital accumulation and inflation. In particular, we explore this issue in a setting in which banks provide risk pooling services. Furthermore, money overcomes incomplete information to facilitate transactions between individuals. In contrast to previous work, we incorporate a market for equity by allowing individuals to trade capital across generations. Interestingly, we find that the quantitative impact of the stock market may be indeterminate — the economy may respond with significant gains in capital accumulation or relatively little. Consequently, it is not clear how much financial development will drive down inflation in the longrun. In the case of unique steady-states, expansionary monetary policy causes long-run capital accumulation to fall. However, the response is much stronger in the presence of a stock market. Furthermore, the market for capital may lead to a different qualitative response to monetary policy. That is, financial development may lead to a Tobin effect from inflation. Finally, by studying dynamics, we demonstrate that financial markets and monetary policy can have a significant impact on volatility in the economy. In this manner, there is additional scope for monetary policy to stabilize the economy at higher levels of financial development.Monetary Policy, Stock Market, Economic Development

Liquidity Risk, Economic Development, and the Effects of Monetary Policy

Empirical evidence indicates that monetary policy is not super-neutral in many countries. In particular, in high in?ation economies, in?ation is negatively related to economic activity. By comparison, in?ation may be positively correlated with output in low in?ation countries. We present a neoclassical growth model with money in which the incidence of liquid- ity risk is inversely related to aggregate capital formation. Interestingly, there may be multiple monetary steady-states where the e¤ects of mon- etary policy vary. In poor economies, the ?nancial system is highly dis- torted and higher rates of money growth are associated with less capital formation. In contrast, in advanced economies, a Tobin e¤ect is observed. Since in?ation exacerbates distortions from a coordination failure in the low capital steady-state, individuals become much more exposed to liq- uidity risk. Consequently, optimal monetary policy depends on the level of development.Economic Development, Banks, Monetary Policy

The Role of Financial Sector Competition for Monetary Policy

In this paper, we examine the impact of competition in the banking industry on ?nancial market activity. In particular, we explore this issue in a setting where banks simultaneously insure individuals against liquid- ity risk and o¤er loans to promote intertemporal consumption smoothing. In addition, spatial separation and private information generate a trans- actions role for money. Interestingly, we demonstrate that the industrial organization of the ?nancial system bears signi?cant implications for the e¤ects of monetary policy. Under perfect competition, higher rates of money growth lead to lower interest rates and a higher volume of lending activity. In contrast, in a monopoly banking sector, money growth restricts the availability of funds and raises the cost of borrowing.Monetary Policy, Financial Sector Concentration, Price Competition

Financial Development and the Distributional Effects of Monetary Policy Do the distributional consequences of monetary policy depend on the extent of financial development? Should optimal monetary policy vary across countries? In order to answer these questions, we develop a monetary growth production model with heterogeneous agents. In our economy, optimal policy needs to weigh the effects of policy across two groups — capital owners and individuals who hold liquid assets. While banks help limit the exposure to inflation, there are limits because money alleviates the frictions of private information and limited communication. In this environment, we compare two economies that are identical in every aspect except for their level of financial development. In a country with limited financial development, a stock market is absent. In the other, an equity market is active. In either economy, inflation adversely affects capital formation and output. Individuals who hold liquid assets are always adversely affected by inflation, but the attitude of capital owners depends on the level of financial development. In particular, in the presence of a stock market, the impact of inflation on the welfare of capital owners is non-monotonic. Nevertheless, optimal monetary policy is always more conservative at higher levels of financial development.

Financial Development, Friedman Rule, Monetary Policy, Stock Market

Technological diffusion and asset prices

In this manuscript, we demonstrate that sharp declines and increases in the stock market such as the ones that occurred in the early 1970s and mid 1990s in the United States may be attributed to expected rapid technological diffusion.Stock market Asset prices Technological diffusion

The role of financial sector competition for monetary policy

In this paper, we examine the impact of competition in the banking industry on financial market activity. In particular, we explore this issue in a setting where banks simultaneously insure individuals against liquidity risk and offer loans to promote intertemporal consumption smoothing. In addition, spatial separation and private information generate a transactions role for money. Interestingly, we demonstrate that the industrial organization of the financial system bears significant implications for the effects of monetary policy. Under perfect competition, higher rates of money growth lead to lower interest rates and a higher volume of lending activity. In contrast, in a monopoly banking sector, money growth restricts the availability of funds and raises the cost of borrowing.