Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 260 Abstract:
This paper analyses the effects of open market operations on interest rates in a model in which agents must pay a fixed cost to exchange assets and cash. Asset markets are endogenously segmented in that some agents choose to pay the fixed cost and some do not. When the fixed cost is zero, the model reduces to the standard one in which persistent money injections increase nominal interest rates, flatten the yield curve, and lead to a downward-sloping yield curve on average. In contrast, if markets are sufficiently segmented, then persistent money injections decrease interest rates, steepen or even twist the yield curve, and lead to an upward-sloping yield curve on average.
Subject (JEL): E52 - Monetary Policy and E43 - Interest Rates: Determination, Term Structure, and Effects
Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 278 Abstract:
This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a Baumol-Tobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents’ consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.
Keyword: Volatile real exchange rates, Baumol-Tobin model, Liquidity effects, Term structure of interest rates, and Fixed costs Subject (JEL): E52 - Monetary Policy, F31 - Foreign Exchange, E43 - Interest Rates: Determination, Term Structure, and Effects, E40 - Money and Interest Rates: General, and F41 - Open Economy Macroeconomics