Open Market Operations, Eligible Securities, and Macroeconomic Stabilization

This paper examines the role of collateralized money supply for short-run macroeconomic effects of monetary policy. We apply a simple sticky price model, where the central bank supplies money in exchange for securities that are discounted with the nominal interest rate. The central assumption is that only government bonds are eligible as collateral. If they are dominated in rate of return by private debt, there exists a liquidity premium and money injections are associated with a liquidity effect. When the central bank sets the nominal interest rate, the price level and the allocation are uniquely determined, regardless whether prices are perfectly flexible or not. Finally, we consider the case where the central bank sets the nominal interest rate in order to maximize social welfare in a discretionary way. Inflation is less volatile when money supply is unconstrained, while output fluctuations are smaller under a binding money market constraint. When households are very risk avers, social welfare can be raised by a collateralized money supply if the stock of eligible securities is constant. JEL classification: E5, E32.