Outside Versus Inside Bonds: A Modigliani-Miller Type Result for Liquidity Constrained Economies
University of Basel - Economics Department; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Christopher J. Waller
University of Notre Dame - Department of Economics
December 9, 2010
CESifo Working Paper Series No. 3272
When agents are liquidity constrained, two options exist - sell assets or borrow. We compare the allocations arising in two economies: in one, agents can sell government (outside) bonds and in the other they can borrow by issuing (inside) bonds. All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds but that the converse is not true. However, the optimal policy in each economy makes the allocations equivalent.
Number of Pages in PDF File: 42
Keywords: liquidity, financial markets, monetary policy, search
JEL Classification: E40, E50working papers series
Date posted: December 9, 2010
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