Asset prices, liquidity, and monetary policy in the search theory of money
Abstract: The author presents a search-based model in which money coexists with equity shares on a risky aggregate endowment. Agents can use equity as a means of payment, so shocks to equity prices translate into aggregate liquidity shocks that disrupt the mechanism of exchange. The author characterizes a family of optimal monetary policies and finds that the resulting equity prices are independent of monetary considerations. The author also studies monetary policies that target a constant, but nonzero, nominal interest rate and finds that to the extent that a financial asset is valued as a means to facilitate transactions, the asset's real rate of return will include a liquidity return that depends on monetary considerations. Through this liquidity channel, persistent deviations from an optimal monetary policy can cause the real prices of assets that can be used to relax trading constraints to exhibit persistent deviations from their fundamental values.
Status: Published in Selected Articles from the Thirty-Fourth Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis
File(s): File format is application/pdf https://files.stlouisfed.org/files/htdocs/publications/review/10/07/Lagos.pdf
Provider: Federal Reserve Bank of St. Louis
Part of Series: Review