Interest Rates in a General Equilibrium Baumol-Tobin Model

Jonathan H. Heathcote, Georgetown University

Abstract

This paper is a version of Romer’s general equilibrium interpretation of the Baumol-Tobin model. It investigates the implications for the behavior of the real interest rate of modelling money demand as arising endogenously from costs associated with trading in asset markets. Under a particular rule for tax policy, I look at the implications for real and nominal rates of an unexpected shock to inflation.