Frictional asset markets and the liquidity channel of monetary policy

On the optimal quantity of liquid bonds

“…Similar to what we do, Herrenbrueck (2014) integrates an over-the-counter market in the spirit of Duffie et al (2005) into a New Monetarist framework. Like Williamson (2012Williamson ( , 2015Williamson ( , 2016), Herrenbrueck assumes take-it-or-leave-it offers in the secondary financial market, while we assume that agents bargain over the terms of trade in bilateral meetings.…”

“…where φm = φM −1 = q and φm =q. 28 The model's money demand depends on the interest rate in the primary bond market i ≡ 1/ρ − 1, and on α and A via u (q) and U (x). We estimate the model's elasticity of money demand with respect to i in the same way as its empirical counterpart; i.e., by ordinary least squares and a log-log specification.…”

“…Derivation of (28). The marginal value of money of an agent at the beginning of a period can be written as…”

“…whereq 2 andq 2 are the equilibrium outputs at B = B 32 (γ) under the type-II equilibrium, andq 3 , q 3 are the equilibrium outputs at B = B 32 (γ) under the type-III equilibrium. By (28) and (34),…”

“…The elasticity of money demand with respect to the 3-month T-Bill rate is estimated by ordinary least squares and a log-log specification. Note that since we do not know ex-ante in which equilibrium the economy is, we cannot assume that the Fisher equation holds in order to estimate β 28. The model's money demand is defined as the ratio of the real stock of money, φM−1 = φm = q, divided by the real output of the economy, Y .…”