A note on the societal benefits of illiquid bonds

Kocherlakota (2003) provides an example of a monetary economy where efficiency is enhanced with the introduction of a nominally risk-free bond that is specifically designed to be illiquid. The societal benefit of an illiquid bond in his example, however, is transitory, and he does not characterize an optimal policy. I use an analytically tractable framework to characterize an optimal intervention and to show that the purported benefits of an illiquid bond market persist in a steady state.