Money, Interest Rates, and Exchange Rates with Endogenously Segmented Asset Markets

40 Pages Posted: 1 Sep 2000 Last revised: 18 Oct 2010

See all articles by Fernando Alvarez

Fernando Alvarez

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Andrew Atkeson

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER)

Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department; University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: September 2000

Abstract

This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a Baumol-Tobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents' consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.

Suggested Citation

Alvarez, Fernando and Atkeson, Andrew G. and Kehoe, Patrick J., Money, Interest Rates, and Exchange Rates with Endogenously Segmented Asset Markets (September 2000). NBER Working Paper No. w7871. Available at SSRN: https://ssrn.com/abstract=240774

Fernando Alvarez (Contact Author)

University of Chicago - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Andrew G. Atkeson

University of California, Los Angeles (UCLA) - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
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612-204-5525 (Phone)
612-204-5515 (Fax)

University of Minnesota - Twin Cities - Department of Economics ( email )

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Minneapolis, MN 55455
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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