Liquidity provision,interest rates,and unemployment |
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| Institution: | 1. Columbia University, Department of Economics, International Affairs Building, 420 West 118th St., New York, NY 10027, United States;2. NBER, United States;1. Paris School of Economics, University of Paris 1 Panthéon-Sorbonne, and CEPR, France;2. Australian National University, CAMA, and EABCN, Australia;3. University .of Washington, CEPR, EABCN, and NBER, United States;1. Harvard University, USA;2. Bank of International Settlements, Switzerland;3. INSEAD, France;1. Department of Economics and CIREQ, Université de Montréal, C.P. 6128, succ. Centre-Ville, Montréal, Québec, Canada H3C 3J7;2. Trade Policy Review Division, World Trade Organization, Rue de Lausanne 154, 1211 Geneva, Switzerland |
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| Abstract: | The effective liquidity supply of the economy—the weighted-sum of all assets that serve as media of exchange—matters for interest rates and unemployment. We formalize this idea by adding an over-the-counter market with collateralized trades to the Mortensen–Pissarides model. An increase in public liquidity through a higher supply of real government bonds raises the real interest rate, crowding out private liquidity and increasing unemployment. If unemployment is inefficiently high, keeping liquidity scarce can be socially optimal. A liquidity crisis affecting the acceptability of private assets as collateral widens the rate-of-return difference between private and public liquidity, also increasing unemployment. |
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| Keywords: | Unemployment Liquidity Interest rates |
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