Munich Personal RePEc Archive

Differences of Opinion, Liquidity, and Monetary Policy

Johnson, Christopher (2016): Differences of Opinion, Liquidity, and Monetary Policy.

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Abstract

Liquidity considerations are important in understanding the relationship between asset prices and monetary policy. Differences of opinion regarding the future value of an asset can affect liquidity of not only the underlying asset, but also of competing media of exchange, such as money. I consider a monetary search framework in which money and risky assets can facilitate trade, but where the asset is an opinion-sensitive medium of exchange in that traders may disagree on its future price. A pecking-order theory of payments is established between money and risky assets, which can go in either direction depending on the respective beliefs of both agents in a bilateral trade. In short, optimists prefer to use money over assets, whereas pessimists prefer to use assets over money. In contrast to a majority of the differences of opinion literature, not only do pessimists actively participate in the purchasing of assets, but in some cases their demand coincides with that of optimists. Additionally, in support of Bernanke and Gertler (2000), I find that monetary policy aimed at reducing asset price volatility need not be welfare-maximizing. Instead, the Friedman rule is welfare-maximizing.

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