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Optimal Liquidity and Economic Stability

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  • Linghui Han
  • Il Houng Lee
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    Abstract

    Monetary aggregates are now much less used as policy instruments as identifying the right measure has become difficult and interest rate transmission has worked well in an increasingly complex financial system. In this process, little attention was paid to the potential spillover of excess liquidity. This paper suggests a notional level of "optimal" liquidity beyond which asset prices will start to rise faster than the GDP deflator, thereby creating a gap between the face value and the real purchasing value of financial assets and widen the wedge in income between those with capital stock and those living on salaries. Such divergence will eventually lead to an abrupt and disorderly adjustment of the asset value, with repercussions on the real sector.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/135.

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    Length: 23
    Date of creation: 01 May 2012
    Date of revision:
    Handle: RePEc:imf:imfwpa:12/135

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    Related research

    Keywords: Monetary policy; Liquidity; Monetary aggregates; financial assets; financial sector; monetary aggregate; financial institutions; money demand; inflation; present value; monetary fund; money market; net present value; financial system; bonds; central bank; financial market; monetary authorities; quantity theory of money; theory of money; stock of capital; stock market; stock exchange; discount rate; financial intermediation; bond; long-term interest rates; financial innovation; monetary policy instrument; treasury securities; monetary stability; money market mutual funds; monetary policy implications; financial liberalization; corporate bonds; bond markets; stock price; stock capital; demand for money; monetary expansion;

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    1. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, The MIT Press, edition 2, volume 1, number 0262232316, December.
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