Economic Theory

, Volume 59, Issue 2, pp 355–375 | Cite as

Monetary transaction costs and the term premium

  • Raphael EspinozaEmail author
  • Dimitrios Tsomocos
Research Article


We show that, in a monetary equilibrium, trade and asset prices depend on both the supply of liquidity by the central bank and the liquidity of assets and commodities. Because money demand is a function of the liquidity of assets and commodities, monetary aggregates provide information on trade inefficiencies and are thus instructive for the conduct of monetary policy. We also show that assets that promise higher payoffs in liquidity constrained states in the future are relatively more expensive. This generates a term premium in the yield curve, even in absence of aggregate real uncertainty. The term premium is also higher than what would be calibrated in a representative agent model because monetary costs affect individual agents’ marginal utilities even if aggregate income is unaffected. Our results hold in any monetary economy with heterogeneous agents and short-term liquidity effects, where monetary costs act as transaction costs and the quantity theory of money is verified.


Liquidity Cash-in-advance constraints Monetary aggregates  Term structure of interest rates 

JEL Classification

E43 G12 


  1. Aiyagari, S.R.: Uninsured idiosyncratic risk and aggregate saving. Q. J. Econ. 109(3), 659–684 (1994)CrossRefGoogle Scholar
  2. Backus, D., Gregory, A., Zin, S.: Risk premiums in the term structure: evidence from artificial economies. J. Monet. Econ. 24(3), 371–399 (1989)CrossRefGoogle Scholar
  3. Bansal, R., Coleman II, W.J.: A monetary explanation of the equity premium, term premium and risk-free rate puzzles. J. Polit. Econ. 104(6), 1135–1171 (1996)CrossRefGoogle Scholar
  4. Bloize, G., Dreze, J.H., Polemarchakis, H.: Monetary economy over infinite horizon. Econ. Theory 25(1), 51–74 (2005)Google Scholar
  5. Breeden, D.: An intertemporal asset pricing model with stochastic consumption and investment opportunities. J. Financ. Econ. 7, 265–296 (1979)CrossRefGoogle Scholar
  6. Chabi-Yo, F., Leisen, D., Renault, E.: Implications of Asymmetry Risk for Portfolio Analysis and Asset Pricing. Bank of Canada Working Paper 2007-47 (2007)Google Scholar
  7. Clower, B.W.: A reconsideration of the microeconomic foundations of monetary theory. West. Econ. J. 6, 1–8 (1967)Google Scholar
  8. Cox, J., Ingersoll, J., Ross, S.: An intertemporal general equilibrium of asset prices. Econometrica 53, 363–384 (1985a)CrossRefGoogle Scholar
  9. Cox, J., Ingersoll, J., Ross, S.: A theory of the term structure of interest rates. Econometrica 53, 385–407 (1985b)CrossRefGoogle Scholar
  10. Dubey, P., Geanakoplos, J.: The value of money in a finite-horizon economy: a role for banks. In: Dasgupta, P., Gale, D., et al. (eds.) Economic Analysis of Market and Games. MIT Press, Cambridge MA (1992)Google Scholar
  11. Dubey, P., Geanakoplos, J.: Monetary equilibrium with missing markets. J. Math. Econ. 39, 585–618 (2003)CrossRefGoogle Scholar
  12. Dubey, P., Geanakoplos, J.: Real determinacy with nominal assets and outside money. Econ. Theory 27, 79–106 (2006)CrossRefGoogle Scholar
  13. Elul, R.: Financial innovation, precautionary saving and the risk-free rate. J. Math. Econ. 27, 113–131 (1997)CrossRefGoogle Scholar
  14. Espinoza, R., Goodhart, C., Tsomocos, D.: State prices, liquidity and default. Econ. Theory 39(2), 177–194 (2009)CrossRefGoogle Scholar
  15. Espinoza, R., Tsomocos, D.: Monetary Transaction Costs and the Term Premium. IMF Working Paper 13/85. International Monetary Fund, Washington, DC (2013)Google Scholar
  16. Fan, M.: Heterogeneous beliefs, the term structure and time-varying risk premia. Ann. Financ. 2, 259–285 (2006)CrossRefGoogle Scholar
  17. Fisher, I.: The Purchasing Power of Money. MacMillan, New York (1911)Google Scholar
  18. Grandmont, J.M., Younes, Y.: On the role of money and the existence of a monetary equilibrium. Rev. Econ. Stud. 39, 355–372 (1972)CrossRefGoogle Scholar
  19. Grossman, S., Melino, A., Shiller, R.: Estimating the continuous time consumption based asset pricing model. J. Bus. Econ. Stat. 5(3), 315–327 (1987)Google Scholar
  20. Gurley, J.G., Shaw, E.S.: Money in a Theory of Finance. The Brookings Institution, Washington, DC (1960)Google Scholar
  21. Kiyotaki, N., Wright, R.: On money as a medium of exchange. J. Polit. Econ. 97(4), 927–954 (1989)CrossRefGoogle Scholar
  22. Lagos, R., Wright, R.: A unified framework for monetary theory and policy analysis. J. Polit. Econ 113(3), 463–484 (2005)CrossRefGoogle Scholar
  23. Lagos, R.: Asset prices and liquidity in an exchange economy. J. Monet. Econ. 57, 913–930 (2010)CrossRefGoogle Scholar
  24. Lucas, R.: Asset prices in an exchange economy. Econometrica 46(6), 1429–1445 (1978)CrossRefGoogle Scholar
  25. Lucas, R., Stokey, N.: Optimal fiscal and monetary policy in an economy without capital. J. Monet. Econ. 12, 55–93 (1983)CrossRefGoogle Scholar
  26. Lucas, R., Stokey, N.: Money and interest in a cash-in-advance economy. Econometrica 55(3), 491–513 (1987)CrossRefGoogle Scholar
  27. Peiris, M.U., Vardoulakis, A.P.: Savings and default. Econ. Theory 54, 153–180 (2013)CrossRefGoogle Scholar
  28. Piazzesi, M., Schneider, M.: Equilibrium Yield Curves. NBER Working Paper 12609. National Bureau of Economic Research, Cambridge, MA (2006)Google Scholar
  29. Radner, R.: Existence of equilibrium of plans, prices, and price expectations in a sequence of markets. Econometrica 40(2), 289–303 (1972)CrossRefGoogle Scholar
  30. Rudebusch, G.D., Swanson, E.T.: Examining the bond premium puzzle with a DSGE model. J. Monet. Econ. 55, S111–S126 (2008)Google Scholar
  31. Shubik, M., Tsomocos, D.P.: A Strategic market game with a mutual bank with fractional reserves and redemption in gold (a continuum of traders). J. Econ. 55(2), 123–150 (1992)CrossRefGoogle Scholar
  32. Shubik, M., Wilson, C.: The optimal bankruptcy rule in a trading economy using fiat money. J. Econ. 37(3–4), 337–354 (1977)CrossRefGoogle Scholar
  33. Svensson, L.E.O.: Money and asset prices in a cash-in-advance economy. J. Polit. Econ. 93(5), 919–944 (1985)CrossRefGoogle Scholar
  34. Tsomocos, D.P.: Generic determinacy and money non-neutrality of international monetary equilibria. J. Math. Econ. 44(7–8), 866–887 (2008)CrossRefGoogle Scholar
  35. van der Schaar, M., Xu, J., Zame, W.: Efficient online exchange via fiat money. Econ. Theory 54, 211–248 (2013)CrossRefGoogle Scholar
  36. Wachter, J.: A consumption-based model of the term structure of interest rates. J. Financ. Econ. 79, 365–399 (2006)CrossRefGoogle Scholar
  37. Weil P.: Equilibrium Asset Prices with Undiversifiable Labor Income Risk. NBER Working Paper No. 3975 (1992)Google Scholar
  38. Woodford, M.: Control of the Public Debt: A Requirement for Price Stability? NBER Working Paper No. 5684 (1996)Google Scholar
  39. Woodford, M.: Price-Level Determination Under Interest Rate Rules. Department of Economics, Princeton University, Mimeo (1999)Google Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 2014

Authors and Affiliations

  1. 1.Research DepartmentInternational Monetary FundWashingtonUSA
  2. 2.SSEES, University College LondonLondonUK
  3. 3.Said Business School and St Edmund HallUniversity of OxfordOxfordUK

Personalised recommendations