We present a monetary model with segmented asset markets that
implies a persistent fall in interest rates after a once and for all increase
in liquidity. The gradual propagation mechanism produced
by our model is novel in the literature. We provide an analytical
characterization of this mechanism, showing that the magnitude
of the liquidity effect on impact, and its persistence, depend
on the ratio of two parameters: the long-run interest rate elasticity
of money demand and the intertemporal substitution elasticity.
The model simultaneously explains the short-run "instability"
of money demand estimates as-well-as the stability of long-run
interest-elastic money demand.
Alvarez, Fernando, and Francesco Lippi.
"Persistent Liquidity Effects and Long-Run Money Demand."
American Economic Journal: Macroeconomics,
General Aggregative Models: Neoclassical
Price Level; Inflation; Deflation
Demand for Money
Interest Rates: Determination, Term Structure, and Effects