Persistent Liquidity Effects and Asset Pricing in a General Equilibrium Model with Production

Abstract

This paper provides an explicit solution to a limited participation model with power utility. With power utility, current consumption growth is shown to depend on last period's consumption growth rate. An unanticipated monetary expansion affects consumption growth via an inflation tax on dividends and an employment effect. Since future consumption growth depends on current consumption growth, a money shock persists in consumption growth rates. Asset returns are a function of consumption growth, so liquidity effects persist in asset returns.

JEL Classification: G12