DP4336 Tobin's Imperfect Asset Substitution in Optimizing General Equilibrium

Author(s): Javier Andrés , J David López-Salido , Edward Nelson

Publication Date: March 2004

Keyword(s): transmission mechanism , imperfect asset substitution , monetary policy , term structure

JEL(s): E52 , E58

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP4336.asp

In this Paper, we present a dynamic optimizing model that allows explicitly for imperfect substitutability between different financial assets. This is specified in a manner that captures Tobin’s (1969) view that an expansion of one asset’s supply affects both the yield on that asset and the spread or ‘risk premium’ between returns on that asset and alternative assets. Our estimates of this model on US data confirm that some of the observed deviations of long-term rates from the expectations theory of the term structure can be traced to movements in the relative stocks of financial assets. The richer aggregate demand and asset specifications imply that there exists an additional channel of monetary policy. Our results suggest that central bank operations exercise a modest influence on the relative prices of alternative financial securities, and so exert an extra effect on long-term yields and aggregate demand separate from their effect on the expected path of short-term rates.