## :: Working papers ::

**Interest Rates, Moneyness, and the Fisher Equation**

Lucas Herrenbrueck

*SFU working paper (2019)*

Latest version

**Asset Safety vs Asset Liquidity**

Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee

*UC Davis working paper (2018)*

Latest version (2018)

**The Liquidity-Augmented Model of Macroeconomic Aggregates**

Athanasios Geromichalos and Lucas Herrenbrueck

*SFU working paper (2017)*

Latest version (revised 2019); FAQ

**The Strategic Determination of the Supply of Liquid Assets**

Athanasios Geromichalos and Lucas Herrenbrueck

(Earlier working title: Fiscal Games on a Monetary Turf)

*UC Davis working paper (2016)*

Latest version (revised 2018); online appendix; Mathematica code

## :: Published and forthcoming ::

**Frictional Asset Markets and the Liquidity Channel of Monetary Policy**

Lucas Herrenbrueck

*Journal of Economic Theory*

Published version (2019); accepted version

Previously circulated as:

**Quantitative Easing and the Liquidity Channel of Monetary Policy**

*SFU working paper (2014)*

Last working paper version (revised 2016)

**Smart-Dating in Speed-Dating: How a Simple Search Model Can Explain Matching Decisions**

Lucas Herrenbrueck, Xiaoyu Xia, Paul Eastwick, and Chin Ming Hui

*European Economic Review*

Published version (2018); working paper version

**Instability of Endogenous Price Dispersion Equilibria: a Simulation**

Lucas Herrenbrueck

*Canadian Journal of Economics*

Published version (2018); working paper version; Mathematica code; replication instructions

**An Open-Economy Model with Money, Endogenous Search, and Heterogeneous Firms**

Lucas Herrenbrueck

*Economic Inquiry*

Published version (2017); working paper version

**A Tractable Model of Indirect Asset Liquidity**

Lucas Herrenbrueck and Athanasios Geromichalos

*Journal of Economic Theory*

Published version (2017); working paper version

**A Search-Theoretic Model of the Term Premium**

Athanasios Geromichalos, Lucas Herrenbrueck, and Kevin Salyer

*Theoretical Economics*

Published version (2016); working paper version; online appendix

**Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets**

Athanasios Geromichalos and Lucas Herrenbrueck

*Journal of Money, Credit and Banking*

Published version (2016); working paper version; online appendix

## :: Work in progress ::

**No Elephant in the Room? Noisy Convergence and the Global Growth Incidence Curve**

Lucas Herrenbrueck

*Work in progress*

**Computational Liquidity Economics**

Lucas Herrenbrueck and Zijian Wang

*Work in progress*

**Optimal Monetary Policy, Currency Unions, and the Eurozone Divergence**

Lucas Herrenbrueck

*Draft working paper (2015);*latest version

## :: Projects and interests ::

Liquidity traps

Computational heterogeneous agent modeling

Properties of monetary equilibria near the Friedman Rule

Properties of equilibrium and disequilibrium in search and matching models

Computational heterogeneous agent modeling

Properties of monetary equilibria near the Friedman Rule

Properties of equilibrium and disequilibrium in search and matching models

## :: List of all papers, with abstracts ::

**12. Interest Rates, Moneyness, and the Fisher Equation**

Lucas Herrenbrueck

*SFU working paper (2019);*latest version

Abstract: The Euler equation of a representative consumer -- or its long-run counterpart, the Fisher equation -- is at the heart of modern macroeconomics. But in empirical applications, it is badly misapplied: it prices a bond that is short-term, perfectly safe, yet perfectly illiquid. Such a bond does not exist. Real-world safe assets are highly tradable or pledgeable as collateral, hence their prices reflect their

*moneyness*as much as their dividends. Indeed, I estimate the return on a hypothetical illiquid bond, for the postwar United States, via inflation and consumption growth, and show that it behaves very differently from the return on safe and liquid assets. I also argue that this distinction helps resolve a great number of puzzles associated with the Euler/Fisher equation, and points to a better way of understanding how monetary policy affects the economy.

**11. Asset Safety vs Asset Liquidity**

Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee

*UC Davis working paper (2018);*latest version

Abstract: Recently, a lot of attention has been paid to the role "safe and liquid assets" play in the macroeconomy. Many economists take as given that safer assets will also be more liquid, and some go a step further by practically using the two terms as synonyms. However, they are not synonyms: safety refers to the probability that the (issuer of the) asset will pay the promised cash flow, and liquidity refers to the ease with which an asset can be sold if needed. Mixing up these terms can lead to confusion and wrong policy recommendations. In this paper, we build a multi-asset model in which an asset’s safety and liquidity are well-defined and distinct from one another. Treating safety as a primitive, we examine the relationship between an asset’s safety and liquidity in general equilibrium. We show that the commonly held belief that “safety implies liquidity” is generally justified, but there may be exceptions. We then describe the conditions under which a relatively riskier asset can be more liquid than its safe(r) counterparts. Finally, we use our model to rationalize the puzzling observation that AAA corporate bonds are considered less liquid than (the riskier) AA corporate bonds.

**10. The Liquidity-Augmented Model of Macroeconomic Aggregates**

Athanasios Geromichalos and Lucas Herrenbrueck

*SFU working paper (2017);*latest version; FAQ

Abstract: We propose a new model of the macroeconomy which is simple and tractable, yet explicit about the foundations of liquidity. Monetary policy is implemented via swaps of money for liquid bonds in a secondary asset market, and these have real effects because money, bonds, and capital are imperfect substitutes. The model unifies two classical channels through which the price of liquidity affects the economy (Friedman's real balance effect vs Mundell's and Tobin's asset substitution effect), and it shines light on important macroeconomic questions: optimal monetary policy in the long run, the causal link between interest rates and inflation, and the existence and persistence of a liquidity trap where interest rates are zero but inflation is positive.

**9. The Strategic Determination of the Supply of Liquid Assets**

Athanasios Geromichalos and Lucas Herrenbrueck

(Earlier working title: Fiscal Games on a Monetary Turf)

*UC Davis working paper (2016);*latest version (revised 2018); online appendix; Mathematica code

Abstract: We study the joint determination of asset supply and asset liquidity in a model where financial assets can be liquidated for money in over-the-counter (OTC) secondary markets. Traders choose to enter the market where they expect to find the best terms; understanding this, asset issuers choose their quantities strategically in order to profit from the liquidity services their assets confer. We find that small differences in OTC microstructure can induce very large differences in the relative liquidity of two assets. Our model has a number of applications, including the superior liquidity of US Treasuries over equally safe corporate debt.

**8. A Tractable Model of Indirect Asset Liquidity**

Lucas Herrenbrueck and Athanasios Geromichalos

*Journal of Economic Theory (2017);*published version; working paper version

Abstract: Assets have "indirect liquidity" if they cannot be used as media of exchange, but can be traded to obtain a medium of exchange (money) and thereby inherit monetary properties. This essay describes a simple dynamic model of indirect asset liquidity, provides closed form solutions for real and nominal assets, and discusses properties of the solutions. Some of these are standard: assets are imperfect substitutes, asset demand curves slope down, and money is not always neutral. Other properties are more surprising: prices are flexible but appear sticky, and an increase in the supply of indirectly liquid assets can decrease welfare. Because of its simplicity, the model can be useful as a building block inside a larger model, and for teaching concepts from monetary theory.

**7. Smart-Dating in Speed-Dating: How a Simple Search Model Can Explain Matching Decisions**

Lucas Herrenbrueck, Xiaoyu Xia, Paul Eastwick, and Chin Ming Hui

*European Economic Review (2018);*published version; working paper version

Abstract: How do people in a romantic matching situation choose a potential partner? We study this question in a new model of matching under search frictions, which we estimate using data from an existing speed dating experiment. We find that attraction is mostly in the eye of the beholder and that the attraction between two potential partners has a tendency to be mutual. These results are supported by a direct measure of subjective attraction. We also simulate the estimated model, and it predicts rejection patterns, matching rates, and sorting outcomes that fit the data very well. Our results are consistent with the hypothesis that people in a romantic matching situation act strategically and have at least an implicit understanding of the nature of the frictions and of the strategic equilibrium.

**6b. Frictional Asset Markets and the Liquidity Channel of Monetary Policy**

Lucas Herrenbrueck

*Journal of Economic Theory*(2019)

*;*published version; accepted version

Abstract: How do central bank purchases of illiquid assets affect asset prices and the real economy? To answer this question, I construct a model with heterogeneous households – some households need money more urgently than others and thus hold more of it. Households (and the government) can trade in frictional asset markets. I find that open market purchases are fundamentally different from helicopter drops: asset purchases stimulate private demand for consumption goods at the expense of demand for assets, while helicopter drops do the reverse. When assets are already scarce, further purchases crowd out the private flow of funds and can cause high real yields and disinflation – a liquidity trap.

**6a. Quantitative Easing and the Liquidity Channel of Monetary Policy**

Lucas Herrenbrueck

*SFU working paper (2014);*last working paper version (revised 2016)

*Published as:*

**6b**(see above)

Abstract: How do central bank purchases of illiquid assets affect interest rates and the real economy? To answer this question, I construct a flexible model of asset liquidity with heterogeneous households - some households need money more urgently than others and hold more of it. Households (and the government) can trade in asset markets, but these are subject to frictions. I find that open market purchases of illiquid assets are fundamentally different from helicopter drops: asset purchases stimulate private demand for consumption goods at the expense of demand for assets and investment goods, while helicopter drops do the reverse. A temporary program of quantitative easing can therefore cause a 'hangover' of elevated yields and depressed investment. When assets are already scarce, further purchases can crowd out the private flow of funds and cause high real yields and disinflation - a liquidity trap. In the long term, lowering the stock of government debt reduces the supply of liquidity but increases the capital-output ratio, so the ultimate impact on output is ambiguous.

**5. Instability of Endogenous Price Dispersion Equilibria: a Simulation**

Lucas Herrenbrueck

*Canadian Journal of Economics*(2018)

*;*published version; working paper version; Mathematica code; replication instructions

Abstract: Models of price posting by firms and search by consumers (such as Burdett and Judd, 1983), often feature equilibria with endogenous price dispersion. However, such equilibria are strategically fragile. In order to investigate how robust they are in the absence of an external coordination mechanism, I simulate various protocols firms may use to update their prices. Despite firms being myopic, some protocols yield results close to the benchmark model. If firms rush to update before observing competitors' actions, profits are higher on average but volatile and cyclical. With cost dispersion, prices become more stable as they are more closely tied to costs. All results are robust to moderate menu costs.

**4. A Search-Theoretic Model of the Term Premium**

Athanasios Geromichalos, Lucas Herrenbrueck, and Kevin Salyer

*Theoretical Economics*(2016); published version; working paper version; online appendix

Abstract: A consistent empirical feature of bond yields is that term premia are, on average, positive. The majority of theoretical explanations for this observation have viewed the term premia through the lens of the consumption based capital asset pricing model. In contrast, we harken to an older empirical literature which attributes the term premium to the idea that short maturity bonds are inherently more liquid. The goal of this paper is to provide a theoretical justification of this concept. To that end, we employ a monetary-search model extended to include assets of different maturities.

Short term assets mature in time to take advantage of random consumption opportunities. Long term assets cannot be used directly to purchase consumption, but agents may liquidate them in a secondary asset market characterized by search and bargaining frictions. Our model delivers three results that are consistent with empirical facts. First, long term assets have higher rates of return in steady state to compensate agents for their relative lack of liquidity. Second, since the difference in the yield of short and long term assets reflects asset market frictions, our model predicts a steeper yield curve for assets that trade in less liquid secondary markets. Third, our model predicts that freshly issued ("on-the-run") assets will sell at higher prices than previously issued ("off-the-run") assets that mature in nearby dates, because sellers of the latter have a more urgent need for liquidity.

**3. Optimal Monetary Policy, Currency Unions, and the Eurozone Divergence**

Lucas Herrenbrueck

*Draft working paper (2015);*latest version

Abstract: What is the optimal inflation rate in an open economy, and when are currency unions a good idea? I investigate these questions using a monetary open economy model where firms have market power because of search frictions. Consumers respond to inflation by increasing their search effort, and as a result, inflation has real and non-monotonic effects. The optimal inflation rate depends on the fundamentals of the economy, such as the disutility of search or the cost of firm entry, and on the inflation rates of trading partners. When countries coordinate their monetary policies, inflation will be lower and welfare will be higher than in non-cooperative equilibrium. However,

*coordinating*policy is not the same as conducting the

*same*policy, and the welfare effects from joining a currency union are asymmetric. Preliminary analysis suggests that the model can account for some features of the macroeconomic divergence within the Eurozone in the 1990s and 2000s.

**2. Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets**

Athanasios Geromichalos and Lucas Herrenbrueck

*Journal of Money, Credit and Banking (2016);*published version; working paper version; online appendix

Abstract: We develop a model where agents can allocate their wealth between a liquid asset, which can be used to purchase consumption goods, and an illiquid asset, which represents a better store of value. Should a consumption opportunity arise, agents may visit a frictional "over-the-counter" secondary asset market where they can exchange illiquid for liquid assets. We characterize how monetary policy affects both the issue price and the secondary market price of the asset. We also show that, in contrast to conventional wisdom, search and bargaining frictions in the secondary asset market can improve welfare if inflation is low.

**1. An Open-Economy Model with Money, Endogenous Search, and Heterogeneous Firms**

Lucas Herrenbrueck

*Economic Inquiry (2017);*published version; working paper version

Abstract: This paper describes a new monetary open-economy model where firms have market power due to search frictions in the goods market, and endogenous search effort by consumers mitigates this market power. The optimal inflation rate depends positively on the cost of search effort and on the cost of firm entry. Higher inflation always improves a country’s terms-of-trade against its trading partners. I also characterize a general class of matching processes which offer a novel approach to modeling firm sales.