Efficient Monetary Allocations and the Illiquidity of Bonds

30 Pages Posted: 23 Dec 2014

See all articles by Gabriele Camera

Gabriele Camera

Chapman University - Economic Science Institute; University of Bologna - Dept. of Economics

Paola Boel

Sveriges Riksbank - Research Division

Date Written: July 2006

Abstract

We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with money and nominal government bonds, but all trades must be monetary. We demonstrate that a deflationary policy à la Friedman cannot sustain the constrained efficient allocation as no-arbitrage imposes too stringent a bound on the return money can pay. The constrained-efficient allocation can be sustained when bonds have positive yields and, under certain conditions, only if they are illiquid. Illiquidity, meaning that bonds cannot be transformed into consumption as easily as cash, is necessary to eliminate arbitrage opportunities due to disparities in shadow interest rates.

Keywords: Money, Heterogeneity, Friedman Rule, Illiquidity

JEL Classification: E4, E5

Suggested Citation

Camera, Gabriele and Boel, Paola, Efficient Monetary Allocations and the Illiquidity of Bonds (July 2006). Available at SSRN: https://ssrn.com/abstract=2541964 or http://dx.doi.org/10.2139/ssrn.2541964

Gabriele Camera (Contact Author)

Chapman University - Economic Science Institute ( email )

Orange, CA 92866
United States

HOME PAGE: http://www1.chapman.edu/~camera/

University of Bologna - Dept. of Economics ( email )

Strada Maggiore 45
Bologna, 40125
Italy

Paola Boel

Sveriges Riksbank - Research Division ( email )

S-103 37 Stockholm
Sweden

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