Publication Type

Journal Article

Publication Date

12-2012

Abstract

We develop a model where the coexistence of money and a higher yielding asset is endogenously obtained when no restriction is placed on the use of either object as a medium of exchange. Due to the presence of uninsurable risks, agents have, in equilibrium, di⁄erent relative valuations of the asset to money, and hence, the use of money as a means of payment is strictly preferred. This endogenous di⁄erence in the willingness of agents to use money over the asset implies that money carries a greater liquidity premium than the asset. We obtain that the asset strictly dominates money in terms of the expected rate of return, except at the Friedman rule. Since buyers are risk neutral with respect to the dividend payment of the asset, they hold both the asset and money despite the rate of return dominance of asset to money. We obtain that for low levels of ination the price of the asset, and therefore its real rate of return, is not a⁄ected by the rate of ination. This is because the asset is not used as a means of payment, only money is, and the price of the asset is given by its fundamental value. But when the ination rate becomes large enough, real balances are so low that buyers will then start using the asset as a means of payment in addition to money, and here, the asset will carry a liquidity premium as well, although it is smaller than that of money. The price of the asset is then increasing in the ination rate, and its real rate of return is therefore negatively correlated with the ination rate.

Keywords

exchange economy, monetary policy, liquidity, inflation, markets, model

Discipline

Finance | Public Economics

Research Areas

Macroeconomics

Publication

Journal of Monetary Economics

Volume

59

Issue

8

First Page

784

Last Page

797

ISSN

0304-3932

Identifier

10.1016/j.jmoneco.2012.10.018

Publisher

Elsevier

Creative Commons License

Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

Additional URL

http://doi.org/10.1016/j.jmoneco.2012.10.018

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