We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with money and nominal government bonds, but all trades must be monetary. We demonstrate that a deflationary policy à la Friedman cannot sustain the constrained-efficient allocation as no-arbitrage imposes too stringent a bound on the return money can pay. The constrained-efficient allocation can be sustained when bonds have positive yields and, under certain conditions, only if they are illiquid. Illiquidity, meaning that bonds cannot be transformed into consumption as easily as cash, is necessary to eliminate arbitrage opportunities due to disparities in shadow interest rates.

Efficient monetary allocations and the illiquidity of bonds / Boel, Paola; Camera, Gabriele*. - In: JOURNAL OF MONETARY ECONOMICS. - ISSN 0304-3932. - STAMPA. - 53:7(2006), pp. 1693-1715. [10.1016/j.jmoneco.2006.02.002]

Efficient monetary allocations and the illiquidity of bonds

Camera, Gabriele
2006

Abstract

We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with money and nominal government bonds, but all trades must be monetary. We demonstrate that a deflationary policy à la Friedman cannot sustain the constrained-efficient allocation as no-arbitrage imposes too stringent a bound on the return money can pay. The constrained-efficient allocation can be sustained when bonds have positive yields and, under certain conditions, only if they are illiquid. Illiquidity, meaning that bonds cannot be transformed into consumption as easily as cash, is necessary to eliminate arbitrage opportunities due to disparities in shadow interest rates.
2006
Efficient monetary allocations and the illiquidity of bonds / Boel, Paola; Camera, Gabriele*. - In: JOURNAL OF MONETARY ECONOMICS. - ISSN 0304-3932. - STAMPA. - 53:7(2006), pp. 1693-1715. [10.1016/j.jmoneco.2006.02.002]
Boel, Paola; Camera, Gabriele*
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/11585/635722
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