Liquidity Premium and the Substitution Between Money and Treasuries
Posted: 11 Sep 2018 Last revised: 3 Jul 2021
Date Written: December 4, 2020
This paper quantifies the substitution between money (bank deposits) and Treasuries. The estimation is significantly different from either zero or perfect substitution. Thus, fixing monetary policy, Treasury supply still affects the liquidity premium. Furthermore, the substitution increases over time. Regressions that miss the economic interactions between quantities and rates are inconclusive, while structural estimations provide superior statistical power. My estimation implies new channels of Treasury supply on the real economy and foreign exchange rates. Furthermore, it helps resolve the government debt valuation puzzle. I also discuss how my findings relate to Nagel (2016).
Keywords: liquidity premium; substitution; Treasury supply; money; debt valuation
JEL Classification: E41, E44, E63, G12
Suggested Citation: Suggested Citation