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Liquidity Effects, Monetary Policy, and the Business Cycle

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Author Info
Christiano, Lawrence J
Eichenbaum, Martin

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Abstract

This paper presents a flexible-price, quantitative general equilibrium model with the property that a positive money supply shock drives the nominal interest rate down, and aggregate employment, output, and the real wage up. These implications are broadly consistent with postwar U.S. data. The two key features of the model that are responsible for its properties are (1) money shocks have a heterogeneous impact on agents and (2) ex post inflexibilities in production give rise to a very low short-run interest elasticity of money demand. In our model, the extent of the drop in the interest rate after a positive money supply shock depends on the degree to which production is ex post inflexible. Given sufficient ex post inflexibility, the model conforms well with the view, widely held within the U.S. Federal System, that the short-run interest rate elasticity for total reserves is very close to zero. Copyright 1995 by Ohio State University Press.

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Publisher Info
Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 27 (1995)
Issue (Month): 4 (November)
Pages: 1113-36
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Handle: RePEc:mcb:jmoncb:v:27:y:1995:i:4:p:1113-36

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Stockman, Alan C., 1981. "Anticipated inflation and the capital stock in a cash in-advance economy," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 387-393. [Downloadable!] (restricted)
  2. Barro, Robert J, 1978. "Unanticipated Money, Output, and the Price Level in the United States," Journal of Political Economy, University of Chicago Press, vol. 86(4), pages 549-80, August. [Downloadable!] (restricted)
  3. Cooley, T.F. & Cho, J.O., 1991. "The Business Cycle with Nominal Contracts," Papers 90-07, Rochester, Business - General.
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  4. Leeper, Eric M. & Gordon, David B., 1992. "In search of the liquidity effect," Journal of Monetary Economics, Elsevier, vol. 29(3), pages 341-369, June. [Downloadable!] (restricted)
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  5. Greenwood, Jeremy & Huffman, Gregory W., 1987. "A dynamic equilibrium model of inflation and unemployment," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 203-228, March. [Downloadable!] (restricted)
  6. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  7. Gali, Jordi, 1992. "How Well Does the IS-LM Model Fit Postwar U.S. Data," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 709-38, May. [Downloadable!] (restricted)
  8. Barro, Robert J, 1977. "Unanticipated Money Growth and Unemployment in the United States," American Economic Review, American Economic Association, vol. 67(2), pages 101-15, March.
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  9. Robert J. Barro & Mark Rush, 1980. "Unanticipated Money and Economic Activity," NBER Chapters, in: Rational Expectations and Economic Policy, pages 23-73 National Bureau of Economic Research, Inc. [Downloadable!]
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  10. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February. [Downloadable!] (restricted)
  11. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April. [Downloadable!] (restricted)
  12. Sims, Christopher A., 1992. "Interpreting the macroeconomic time series facts : The effects of monetary policy," European Economic Review, Elsevier, vol. 36(5), pages 975-1000, June. [Downloadable!] (restricted)
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  13. Fuerst, Timothy S, 1994. "Optimal Monetary Policy in a Cash-in-Advance Economy," Economic Inquiry, Oxford University Press, vol. 32(4), pages 582-96, October.
  14. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280. [Downloadable!] (restricted)
  15. Finn E. Kydland, 1989. "The role of money in a business cycle model," Discussion Paper / Institute for Empirical Macroeconomics 23, Federal Reserve Bank of Minneapolis. [Downloadable!]
  16. Steven Strongin, 1992. "The identification of monetary policy disturbances: explaining the liquidity puzzle," Working Paper Series, Macroeconomic Issues 92-27, Federal Reserve Bank of Chicago.
  17. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December. [Downloadable!] (restricted)
  18. Robert G. King, 1991. "Money and business cycles," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  19. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September. [Downloadable!] (restricted)
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