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The Effects of Secondary Markets and Unsecured Credit on Inflation Dynamics

Author

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  • Dominguez, Begona
  • Gomis-Porqueras, Pedro
Abstract
We consider an environment with stochastic trading opportunities and incomplete markets and analyze how trading in secondary markets for government debt and access to unsecured credit affect inflation. When secondary markets are not active, {there exists} a unique monetary steady state where public debt does not affect inflation dynamics. In contrast, we find that when agents trade in secondary markets, agents are buying government bonds above their fundamental value. As a result, Ricardian equivalence does not hold and multiple steady states can not be ruled out as government bonds generate a liquidity premium. In particular, we find that the gross interest payment on public debt is non-linear in bond holdings. {Because of this liquidity premium, real government bonds matter for inflation.} To rule out real indeterminacies, we show that active monetary policy is more likely to deliver a unique monetary steady state regardless the stance of fiscal policy. Moreover, trading in secondary markets further amplify the effectiveness of active monetary policies in reducing steady state inflation. Finally, we show that a spread-adjusted Taylor rule delivers a unique steady state, thus ruling out real indeterminacies.

Suggested Citation

  • Dominguez, Begona & Gomis-Porqueras, Pedro, 2016. "The Effects of Secondary Markets and Unsecured Credit on Inflation Dynamics," MPRA Paper 75096, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:75096
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    References listed on IDEAS

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    Cited by:

    1. Huber, Samuel & Kim, Jaehong, 2017. "On the optimal quantity of liquid bonds," Journal of Economic Dynamics and Control, Elsevier, vol. 79(C), pages 184-200.
    2. Berentsen, Aleksander & Waller, Christopher, 2018. "Liquidity premiums on government debt and the fiscal theory of the price level," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 173-182.

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    More about this item

    Keywords

    taxes; inflation; secondary markets; liquidity premium;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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