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Liquidity Effects of Central Banks' Asset Purchase Programs

Mahmoudi, Babak (2013): Liquidity Effects of Central Banks' Asset Purchase Programs.

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Abstract

This paper constructs a model of the monetary economy with multiple nominal assets. Assets differ in terms of the liquidity services they provide, and money is the most liquid asset. The central bank can implement policies by adjusting the relative supply of money and other assets. I show that the central bank can control the overall liquidity and welfare of the economy by changing the relative supply of assets with different liquidity characteristics. A liquidity trap exists away from the Friedman rule that has a positive real interest rate; the central bank's asset purchase/sale programs may be ineffective in instances of low enough inflation rates. My model also enables me to study the welfare effects of a restriction on trading with government bonds.

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