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Federal Reserve Bank of St. Louis
Working Papers
Tobin's imperfect asset substitution in optimizing general equilibrium
Javier Andres
J. David López-Salido
Edward Nelson
Abstract

In this paper, we present a dynamic optimizing model that allows explicitly for imperfect substitutability between different financial assets. This is specified in a manner which captures Tobin's (1969) view that an expansion of one asset's supply affects both the yield on that asset and the spread or "risk premium" between returns on that asset and alternative assets. Our estimates of this model on U.S. data confirm that some of the observed deviations of long-term rates from the expectations theory of the term structure can be traced to movements in the relative stocks of financial assets. The richer aggregate demand and asset specifications imply that there exists an additional channel of monetary policy. Our results suggest that central bank operations exercise a modest influence on the relative prices of alternative financial securities, and so exert an extra effect on long-term yields and aggregate demand separate from their effect on the expected path of short-term rates.


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Javier Andres & J. David López-Salido & Edward Nelson, Tobin's imperfect asset substitution in optimizing general equilibrium, Federal Reserve Bank of St. Louis, Working Papers 2004-003, 2004.
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Keywords: Monetary policy ; Macroeconomics
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