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Liquidity When It Matters Most: QE and Tobin’s q

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  • Driffill, John
  • Miller, Marcus

Abstract

How and why do financial conditions matter for real outcomes? The ‘workhorse model of money and liquidity’ of Kiyotaki and Moore (2008) shows how--with full employment maintained by flexible prices--shifting credit constraints can affect investment and future aggregate supply. We show that, when the flex-price assumption is dropped, an adverse but temporary liquidity shock can rapidly lead to Keynesian-style demand failure. Optimistic expectations may speed recovery, but simulation results suggest that prompt liquidity infusion by the central bank--i.e. Quantitative Easing--is needed to check prolonged recession.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8511.

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Date of creation: Aug 2011
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Handle: RePEc:cpr:ceprdp:8511

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Keywords: Credit Constraints; Liquidity Shocks; Temporary Equilibrium;

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  1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  2. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  3. Neary, J Peter & Stiglitz, Joseph E, 1983. "Toward a Reconstruction of Keynesian Economics: Expectations and Constrained Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 199-228, Supplemen.
  4. Gauti B. Eggertsson, 2005. "Great expectations and the end of the depression," Staff Reports 234, Federal Reserve Bank of New York.
  5. Benassy, Jean-Pascal, 1975. "Neo-Keynesian Disequilibrium Theory in a Monetary Economy," Review of Economic Studies, Wiley Blackwell, vol. 42(4), pages 503-23, October.
  6. Stephen Wright, 2004. "Measures Of Stock Market Value And Returns For The U.S. Nonfinancial Corporate Sector, 1900-2002," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 50(4), pages 561-584, December.
  7. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  8. Manning, Alan, 1990. "Imperfect Competition, Multiple Equilibria and Unemployment Policy," Economic Journal, Royal Economic Society, vol. 100(400), pages 151-62, Supplemen.
  9. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153, October.
  10. Milne,Alistair, 2009. "The Fall of the House of Credit," Cambridge Books, Cambridge University Press, number 9780521762144.
  11. Robert Shimer, 2009. "Convergence in Macroeconomics: The Labor Wedge," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 280-97, January.
  12. Nobuhiro Kiyotaki & Gauti Eggertsson & Andrea Ferrero & Marco Del Negro, 2010. "The Great Escape? A Quantitative Evaluation of the Fed’s Non-Standard Policies," 2010 Meeting Papers 113, Society for Economic Dynamics.
  13. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
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