Money and Asset Prices in a Cash-in-Advance Economy

Svensson derives the demand for money and the pricing of nominal and real interest rates and other assets in a general-equilibrium, pure-exchange monetary economy by treating money symmetrically with other assets: money is priced by the same asset-pricing equation as a share or a bond, with its “dividend” given by the liquidity services it provides in relaxing a cash-in-advance constraint. The key modeling change from Lucas’s (1982) cash-in-advance model is timing: Svensson’s consumers must choose how much cash to hold before they observe the current state (and hence before they know their desired consumption), rather than after, so money becomes a genuine store of value held against future liquidity needs rather than a mechanical, always-binding transactions balance equal to current spending. This richer timing yields a demand for money with variable income velocity instead of the trivial unit-velocity quantity equation that afflicts most cash-in-advance models, and it lets the paper show, among other results, that permanent changes in monetary expansion move the price level and velocity by more than temporary changes do, that a temporary monetary expansion lowers real but not nominal interest rates while a permanent one raises nominal rates with an ambiguous effect on real rates, and that Friedman’s (1969) optimum monetary policy should be counter- or pro-cyclical depending on whether consumers’ relative risk aversion is low or high.

Trade in Risky Assets

This 1988 American Economic Review paper by Lars Svensson extends the law of comparative advantage from trade in goods to trade in any arbitrarily specified set of risky assets, complete or incomplete. It shows that a country’s autarky (no-trade) price for an asset can always be decomposed into the present value of the asset’s expected return minus a “risk measure” (the covariance of the asset’s payoff with the marginal utility of the country’s future consumption, discounted by its autarky interest rate), and that – exactly as with goods – a country tends on average to import the assets whose autarky price is relatively high. Building on this, the paper derives how four sources of difference between countries – the stochastic properties of their output, their rates of time preference, their degrees of risk aversion, and their subjective beliefs – determine autarky interest rates and risk measures, and hence both which country runs an aggregate capital-account deficit (is a net borrower) and the disaggregated pattern of trade in specific instruments such as sure bonds, stocks (claims to output), and Arrow-Debreu securities. Because the result is a correlation rather than an exact asset-by-asset prediction once more than one asset or more than two countries/goods is allowed, the paper’s claims are consistently stated as “tendencies.”

Lars E. O. Svensson | Macro Paper Warehouse

Money and Asset Prices in a Cash-in-Advance Economy

Trade in Risky Assets