AN ANALYTICAL APPROACH TO THE LIQUIDITY EFFECTS OF MONETARY POLICY

Abstract

This paper characterizes analytically the persistent liquidity effects of a money injection in a model economy with goods market segmentation as well as financial market segmentation. Households in financial sectors receive money transfers from the central bank and have access to the bond market, while others outside financial sectors do not receive money transfers and have no access to the bond market. Also, a shock that causes households to relocate between financial sectors leads to more consumption expenditure for both types of households. This goods market effect then causes a money injection to diffuse through the economy over time, generating persistent liquidity effects even when the money growth shock is transitory. This is empirically important because persistent liquidity effects have been observed in many countries with a relatively low persistence of money growth.