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Liquidity provision, interest rates, and unemployment

Authors
Journal
Journal of Monetary Economics
0304-3932
Publisher
Elsevier
Identifiers
DOI: 10.1016/j.jmoneco.2014.04.006
Keywords
  • Unemployment
  • Liquidity
  • Interest Rates
Disciplines
  • Economics
  • Political Science

Abstract

Abstract The effective liquidity supply of the economy—the weighted-sum of all assets that serve as media of exchange—matters for interest rates and unemployment. We formalize this idea by adding an over-the-counter market with collateralized trades to the Mortensen–Pissarides model. An increase in public liquidity through a higher supply of real government bonds raises the real interest rate, crowding out private liquidity and increasing unemployment. If unemployment is inefficiently high, keeping liquidity scarce can be socially optimal. A liquidity crisis affecting the acceptability of private assets as collateral widens the rate-of-return difference between private and public liquidity, also increasing unemployment.

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