:: Working papers ::
The Real Effects of Financial Disruptions in a Monetary Economy
Miroslav Gabrovski, Athanasios Geromichalos, Lucas Herrenbrueck, Ioannis Kospentaris, and Sukjoon Lee
VCU working paper (2023)
Latest version
Asymmetric Information and the Liquidity Role of Assets
Athanasios Geromichalos, Lucas Herrenbrueck, and Zijian Wang
SSRN working paper (2022)
Latest version
Interest Rates, Moneyness, and the Fisher Equation
Lucas Herrenbrueck and Zijian Wang
SFU working paper (2019/2023)
Latest version
No Elephant in the Room? Noisy Convergence and the Global Growth Incidence Curve
Lucas Herrenbrueck
SFU working paper (2019)
Latest version
Miroslav Gabrovski, Athanasios Geromichalos, Lucas Herrenbrueck, Ioannis Kospentaris, and Sukjoon Lee
VCU working paper (2023)
Latest version
Asymmetric Information and the Liquidity Role of Assets
Athanasios Geromichalos, Lucas Herrenbrueck, and Zijian Wang
SSRN working paper (2022)
Latest version
Interest Rates, Moneyness, and the Fisher Equation
Lucas Herrenbrueck and Zijian Wang
SFU working paper (2019/2023)
Latest version
No Elephant in the Room? Noisy Convergence and the Global Growth Incidence Curve
Lucas Herrenbrueck
SFU working paper (2019)
Latest version
:: Published and forthcoming ::
Asset Safety vs Asset Liquidity
Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee
Journal of Political Economy
Published version (2023); accepted version
The Strategic Determination of the Supply of Liquid Assets
Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee
Review of Economic Dynamics
Published version (2023); accepted version; online appendix
The Liquidity-Augmented Model of Macroeconomic Aggregates: A New Monetarist DSGE Approach
Athanasios Geromichalos and Lucas Herrenbrueck
Review of Economic Dynamics
Published version (2022); accepted version; FAQ; full code for estimates and simulation; Dynare code only
Why a Pandemic Recession Boosts Asset Prices
Lucas Herrenbrueck
Journal of Mathematical Economics
Published version (2021); accepted version
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
Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee
Journal of Political Economy
Published version (2023); accepted version
The Strategic Determination of the Supply of Liquid Assets
Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee
Review of Economic Dynamics
Published version (2023); accepted version; online appendix
The Liquidity-Augmented Model of Macroeconomic Aggregates: A New Monetarist DSGE Approach
Athanasios Geromichalos and Lucas Herrenbrueck
Review of Economic Dynamics
Published version (2022); accepted version; FAQ; full code for estimates and simulation; Dynare code only
Why a Pandemic Recession Boosts Asset Prices
Lucas Herrenbrueck
Journal of Mathematical Economics
Published version (2021); accepted version
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 ::
Inflation and Interest Rates in the Lab
Marieh Azizirad, Lucas Herrenbrueck and Luba Petersen
Money and Banking in the Lab
Lucas Herrenbrueck and Cathy Zhang
Liquidity and Business Cycles Redux
Lucas Herrenbrueck and Johannes P. Strobel
Market Freeze as the Result of Information Frictions
Marieh Azizirad and Lucas Herrenbrueck
Computational Liquidity Economics
Lucas Herrenbrueck and Zijian Wang
Optimal Monetary Policy, Currency Unions, and the Eurozone Divergence
Lucas Herrenbrueck
Draft working paper (2015); latest version
Marieh Azizirad, Lucas Herrenbrueck and Luba Petersen
Money and Banking in the Lab
Lucas Herrenbrueck and Cathy Zhang
Liquidity and Business Cycles Redux
Lucas Herrenbrueck and Johannes P. Strobel
Market Freeze as the Result of Information Frictions
Marieh Azizirad and Lucas Herrenbrueck
Computational Liquidity Economics
Lucas Herrenbrueck and Zijian Wang
Optimal Monetary Policy, Currency Unions, and the Eurozone Divergence
Lucas Herrenbrueck
Draft working paper (2015); latest version
:: Projects and interests ::
When (and how) do cryptoassets become liquid?
Money, credit, banking, and interest rates in the laboratory
Money, credit, banking, and interest rates in the laboratory
:: List of all papers, with abstracts ::
16. The Real Effects of Financial Disruptions in a Monetary Economy
Miroslav Gabrovski, Athanasios Geromichalos, Lucas Herrenbrueck, Ioannis Kospentaris, and Sukjoon Lee
VCU working paper (2023); latest version
Abstract: A large literature in macroeconomics reaches the conclusion that disruptions in financial markets have large negative effects on output and (un)employment. Although diverse, papers in this literature share a common characteristic: they all employ frameworks where money is not explicitly modeled. This paper argues that the omission of money may hinder a model’s ability to evaluate the real effects of financial shocks, since it deprives agents of a payment instrument that they could have used to cope with the resulting liquidity disruption. In a carefully calibrated New-Monetarist model with frictional labor, product, and financial markets we show that the existence of money dampens or even eliminates the real impact of financial shocks, depending on the nature of the shock. We also show that the propagation of financial shocks to the real economy is disciplined
by the inflation level, thus delivering a policy-relevant message: high inflation regimes raise the likelihood of a financial shock turning into a financial crisis.
Miroslav Gabrovski, Athanasios Geromichalos, Lucas Herrenbrueck, Ioannis Kospentaris, and Sukjoon Lee
VCU working paper (2023); latest version
Abstract: A large literature in macroeconomics reaches the conclusion that disruptions in financial markets have large negative effects on output and (un)employment. Although diverse, papers in this literature share a common characteristic: they all employ frameworks where money is not explicitly modeled. This paper argues that the omission of money may hinder a model’s ability to evaluate the real effects of financial shocks, since it deprives agents of a payment instrument that they could have used to cope with the resulting liquidity disruption. In a carefully calibrated New-Monetarist model with frictional labor, product, and financial markets we show that the existence of money dampens or even eliminates the real impact of financial shocks, depending on the nature of the shock. We also show that the propagation of financial shocks to the real economy is disciplined
by the inflation level, thus delivering a policy-relevant message: high inflation regimes raise the likelihood of a financial shock turning into a financial crisis.
15. Asymmetric Information and the Liquidity Role of Assets
Athanasios Geromichalos, Lucas Herrenbrueck, and Zijian Wang
SSRN working paper (2022); latest version
Abstract: Monetary models overwhelmingly feature a particular asset, "money", as the medium of exchange in an economy. However, the adoption of a medium of exchange is endogenous and subject to changes if conditions favor a different asset. We study the liquidity role of a real asset that is subject to asymmetric information. We find that rather than using the asset directly as a medium of exchange, agents prefer to liquidate it for money in a secondary asset market, thus establishing money as the dominant medium of exchange. Furthermore, we show that a decrease in severity of asymmetric information in the secondary asset market can hurt welfare. Finally, we find that inflation is crucial for the determination of key equilibrium variables, such as the volume of trade in the secondary asset market, and the decision of agents to invest in information that reduces the degree of information asymmetry.
Athanasios Geromichalos, Lucas Herrenbrueck, and Zijian Wang
SSRN working paper (2022); latest version
Abstract: Monetary models overwhelmingly feature a particular asset, "money", as the medium of exchange in an economy. However, the adoption of a medium of exchange is endogenous and subject to changes if conditions favor a different asset. We study the liquidity role of a real asset that is subject to asymmetric information. We find that rather than using the asset directly as a medium of exchange, agents prefer to liquidate it for money in a secondary asset market, thus establishing money as the dominant medium of exchange. Furthermore, we show that a decrease in severity of asymmetric information in the secondary asset market can hurt welfare. Finally, we find that inflation is crucial for the determination of key equilibrium variables, such as the volume of trade in the secondary asset market, and the decision of agents to invest in information that reduces the degree of information asymmetry.
14. Why a Pandemic Recession Boosts Asset Prices
Lucas Herrenbrueck
Journal of Mathematical Economics (2021); published version; accepted version
Abstract: Economic recessions are traditionally associated with asset price declines, and recoveries with asset price booms. Standard asset pricing models make sense of this: during a recession, dividends are low and the marginal value of income is high, causing low asset prices. Here, I develop a simple model which shows that this is not true during a recession caused by consumption restrictions, such as those seen during the 2020 pandemic: the restrictions drive the marginal value of income down, and thereby drive asset prices up, to an extent that tends to overwhelm the effect of low dividends.
Lucas Herrenbrueck
Journal of Mathematical Economics (2021); published version; accepted version
Abstract: Economic recessions are traditionally associated with asset price declines, and recoveries with asset price booms. Standard asset pricing models make sense of this: during a recession, dividends are low and the marginal value of income is high, causing low asset prices. Here, I develop a simple model which shows that this is not true during a recession caused by consumption restrictions, such as those seen during the 2020 pandemic: the restrictions drive the marginal value of income down, and thereby drive asset prices up, to an extent that tends to overwhelm the effect of low dividends.
13. No Elephant in the Room? Noisy Convergence and the Global Growth Incidence Curve
Lucas Herrenbrueck
SFU working paper (2019); latest version
Abstract: In recent decades, worldwide incomes have grown enormously. But how has this growth been distributed? According to data from 1988-2008, the percentiles in the middle and at the top of the world income distribution have grown the fastest, while percentiles at the bottom and around 80 (the "global upper middle class") have stagnated (Lakner and Milanovic, 2013). This striking pattern was dubbed the “Elephant curve” and, in media coverage, commonly interpreted as a redistribution of incomes from the global upper middle class towards the top earners, plus fast-growing middle classes in emerging economies (especially China).
However, I show that there is a simpler, statistical, explanation for the Elephant pattern: random (“noisy”) growth affecting individuals whose initial incomes follow a bimodal (two-peaked) distribution. Famously, the world income distribution was indeed bimodal in the 1970s-90s. I simulate a process of income growth with these two features, plus a third - a modest amount of convergence (expected income growth is decreasing in income). The simulated growth incidence curve almost exactly replicates the observed data. Thus, this exercise suggests that the Elephant curve may be a statistical artifact reflecting a historically unique situation, rather than revealing anything about the forces of globalization.
Finally, I review further evidence that also supports the artifact hypothesis, and I discuss additional implications of noisy growth for the very top ("one percenters") and very bottom (eradication of poverty) of the world income distribution.
Lucas Herrenbrueck
SFU working paper (2019); latest version
Abstract: In recent decades, worldwide incomes have grown enormously. But how has this growth been distributed? According to data from 1988-2008, the percentiles in the middle and at the top of the world income distribution have grown the fastest, while percentiles at the bottom and around 80 (the "global upper middle class") have stagnated (Lakner and Milanovic, 2013). This striking pattern was dubbed the “Elephant curve” and, in media coverage, commonly interpreted as a redistribution of incomes from the global upper middle class towards the top earners, plus fast-growing middle classes in emerging economies (especially China).
However, I show that there is a simpler, statistical, explanation for the Elephant pattern: random (“noisy”) growth affecting individuals whose initial incomes follow a bimodal (two-peaked) distribution. Famously, the world income distribution was indeed bimodal in the 1970s-90s. I simulate a process of income growth with these two features, plus a third - a modest amount of convergence (expected income growth is decreasing in income). The simulated growth incidence curve almost exactly replicates the observed data. Thus, this exercise suggests that the Elephant curve may be a statistical artifact reflecting a historically unique situation, rather than revealing anything about the forces of globalization.
Finally, I review further evidence that also supports the artifact hypothesis, and I discuss additional implications of noisy growth for the very top ("one percenters") and very bottom (eradication of poverty) of the world income distribution.
12. Interest Rates, Moneyness, and the Fisher Equation
Lucas Herrenbrueck and Zijian Wang
SFU working paper (2023); latest version; original (2019) version; 2023 slides
Abstract: The Euler equation of a representative consumer – or its long-run counterpart, the Fisher equation – is at the heart of modern macroeconomics. But it prices a bond – short-term, perfectly safe, yet perfectly illiquid – that does not exist in reality, where most safe assets can be easily traded or pledged as collateral to obtain money, or even for goods and services directly, and their prices reflect their moneyness as much as their dividends. In this paper, we deploy a New Monetarist framework to capture these facts and derive implications for monetary policy and asset pricing. Consistent with the model, we find that the return on a hypothetical illiquid bond, estimated via inflation and consumption growth, behaves very differently from the return on safe and liquid assets. 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.
Lucas Herrenbrueck and Zijian Wang
SFU working paper (2023); latest version; original (2019) version; 2023 slides
Abstract: The Euler equation of a representative consumer – or its long-run counterpart, the Fisher equation – is at the heart of modern macroeconomics. But it prices a bond – short-term, perfectly safe, yet perfectly illiquid – that does not exist in reality, where most safe assets can be easily traded or pledged as collateral to obtain money, or even for goods and services directly, and their prices reflect their moneyness as much as their dividends. In this paper, we deploy a New Monetarist framework to capture these facts and derive implications for monetary policy and asset pricing. Consistent with the model, we find that the return on a hypothetical illiquid bond, estimated via inflation and consumption growth, behaves very differently from the return on safe and liquid assets. 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
Journal of Political Economy (2023); published version; accepted version
Abstract: Many economists assume that safer assets are more liquid, and some have practically used "safe" and "liquid" as synonyms. But these terms are not synonyms, and mixing them up can lead to confusion and wrong policy recommendations. We build a multi-asset model where an asset's safety and liquidity are well-defined and distinct, and examine their relationship in general equilibrium. We show that the common belief that "safety implies liquidity" is generally justified, but also identify conditions under which this relationship can be reversed. We use our model to rationalize, qualitatively and quantitatively, a prominent safety-liquidity reversal observed in the data.
Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee
Journal of Political Economy (2023); published version; accepted version
Abstract: Many economists assume that safer assets are more liquid, and some have practically used "safe" and "liquid" as synonyms. But these terms are not synonyms, and mixing them up can lead to confusion and wrong policy recommendations. We build a multi-asset model where an asset's safety and liquidity are well-defined and distinct, and examine their relationship in general equilibrium. We show that the common belief that "safety implies liquidity" is generally justified, but also identify conditions under which this relationship can be reversed. We use our model to rationalize, qualitatively and quantitatively, a prominent safety-liquidity reversal observed in the data.
10. The Liquidity-Augmented Model of Macroeconomic Aggregates: A New Monetarist DSGE Approach
Athanasios Geromichalos and Lucas Herrenbrueck
Review of Economic Dynamics (2022); published version; working paper version (2017-2020); FAQ; full code for estimates and Dynare simulation
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. Prices are flexible, yet policy has real effects because money, bonds, and capital are imperfect substitutes, both in the short run and in the long run. 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: the causal link between interest rates and inflation, the effects of money demand shocks, and the existence and persistence of a liquidity trap where interest rates are zero but inflation is positive.
Athanasios Geromichalos and Lucas Herrenbrueck
Review of Economic Dynamics (2022); published version; working paper version (2017-2020); FAQ; full code for estimates and Dynare simulation
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. Prices are flexible, yet policy has real effects because money, bonds, and capital are imperfect substitutes, both in the short run and in the long run. 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: the causal link between interest rates and inflation, the effects of money demand shocks, 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, Lucas Herrenbrueck, and Sukjoon Lee
(Earlier working title: Fiscal Games on a Monetary Turf)
Review of Economic Dynamics (2023); published version; accepted version; online appendix
Abstract: We study asset liquidity in a model where financial assets can be liquidated for money in over-the-counter (OTC) secondary markets, in response to random liquidity needs. Traders choose to enter the market where they expect to find the best terms, understanding that their chances to trade depend on the entry decision of other investors. We find that small differences in OTC microstructure can induce very large differences in the relative liquidity of two assets. We use our model to rationalize, qualitatively and quantitatively, the superior liquidity of U.S. Treasuries over equally safe corporate debt.
Athanasios Geromichalos, Lucas Herrenbrueck, and Sukjoon Lee
(Earlier working title: Fiscal Games on a Monetary Turf)
Review of Economic Dynamics (2023); published version; accepted version; online appendix
Abstract: We study asset liquidity in a model where financial assets can be liquidated for money in over-the-counter (OTC) secondary markets, in response to random liquidity needs. Traders choose to enter the market where they expect to find the best terms, understanding that their chances to trade depend on the entry decision of other investors. We find that small differences in OTC microstructure can induce very large differences in the relative liquidity of two assets. We use our model to rationalize, qualitatively and quantitatively, the superior liquidity of U.S. 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.
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.
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.
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.
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.
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.
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.
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.
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.
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.