Liquidity risk, economic development, and the effects of monetary policy
AbstractEmpirical evidence indicates that monetary policy is not super-neutral in many countries. In particular, in high inflation economies, inflation is negatively related to economic activity. By comparison, inflation may be positively correlated with output in low inflation countries. We present a neoclassical growth model with money in which the incidence of liquidity risk is inversely related to aggregate capital formation. Interestingly, there may be multiple monetary steady-states where the effects of monetary policy vary. In poor economies, the financial system is highly distorted and higher rates of money growth are associated with less capital formation. In contrast, in advanced economies, a Tobin effect is observed. Since inflation exacerbates distortions from a coordination failure in the low-capital steady-state, individuals become much more exposed to liquidity risk. Consequently, optimal monetary policy depends on the level of development.
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Bibliographic InfoArticle provided by Elsevier in its journal European Economic Review.
Volume (Year): 54 (2010)
Issue (Month): 2 (February)
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Web page: http://www.elsevier.com/locate/eer
Economic development Banks Monetary policy;
Other versions of this item:
- Edgar A. Ghossoub & Robert Reed, . "Liquidity Risk, Economic Development, and the Effects of Monetary Policy," Working Papers 0070, College of Business, University of Texas at San Antonio.
- E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- O42 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Monetary Growth Models
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