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Rethinking the Liquidity Puzzle: Application of a New Measure of the Economic Money Stock

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  • William Barnett

    (Department of Economics, The University of Kansas)

  • Logan Kelly

    (Department of Economics, Bryant University)

  • John Keating

    (Department of Economics, The University of Kansas)

Abstract

Historically, attempts to solve the liquidity puzzle have focused on narrowly defined monetary aggregates, such as non-borrowed reserves, the monetary base, or M1. Many of these efforts have failed to find a short-term negative correlation between interest rates and monetary policy innovations. More recent research uses sophisticated macroeconomic and econometric modeling. However, little research has investigated the role measurement error plays in the liquidity puzzle, since in nearly every case, work investigating the liquidity puzzle has used one of the official monetary aggregates, which have been shown to exhibit significant measurement error. This paper examines the role that measurement error plays in the liquidity puzzle by (i) providing a theoretical framework explaining how the official simple-sum methodology can lead to a liquidity puzzle, and (ii) testing for the liquidity effect by estimating an unrestricted VAR.

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Bibliographic Info

Paper provided by University of Kansas, Department of Economics in its series WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS with number 201002.

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Length: 28 pages
Date of creation: Apr 2010
Date of revision: Apr 2010
Handle: RePEc:kan:wpaper:201002

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Keywords: Liquidity Puzzle; Monetary Policy; Monetary Aggregation; Money Stock; Divisia Index Numbers;

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References

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  1. Logan Kelly, 2011. "The current stock of money: an aggregation theoretic measure of narrowly defined money," Applied Economics Letters, Taylor and Francis Journals, vol. 18(7), pages 659-664.
  2. Barnett, William A. & Chauvet, Marcelle, 2010. "How better monetary statistics could have signaled the financial crisis," MPRA Paper 24721, University Library of Munich, Germany.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the flow of funds," Proceedings, Federal Reserve Bank of Dallas, issue Apr.
  4. William Barnett & Apostolos Serletis & W. Erwin Diewert, 2005. "The Theory of Monetary Aggregation (book front matter)," Macroeconomics 0511008, EconWPA.
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  8. Ben Bernanke & Jean Boivin & Piotr S. Eliasz, 2005. "Measuring the Effects of Monetary Policy: A Factor-augmented Vector Autoregressive (FAVAR) Approach," The Quarterly Journal of Economics, MIT Press, vol. 120(1), pages 387-422, January.
  9. Serletis, Apostolos & Chwee, Victor, 1997. "Resolving The Liquidity Puzzle," Macroeconomic Dynamics, Cambridge University Press, vol. 1(04), pages 720-739, December.
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Citations

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Cited by:
  1. Makram El-Shagi & Sebastian Giesen & Logan J. Kelly, 2011. "The Quantity Theory Revisited: A New Structural Approach," IWH Discussion Papers 7, Halle Institute for Economic Research.
  2. Paul, Sunil & Ramachandran, M., 2011. "Currency equivalent monetary aggregates as leading indicators of inflation," Economic Modelling, Elsevier, vol. 28(4), pages 2041-2048, July.
  3. Makram El-Shagi & Sebastian Giesen & Logan J. Kelly, 2012. "Monetary Policy in a World Where Money (Also) Matters," IWH Discussion Papers 6, Halle Institute for Economic Research.
  4. Antonis Michis, 2011. "Multiscale Analysis of the Liquidity Effect," Working Papers 2011-5, Central Bank of Cyprus.
  5. Kemal Bagzibagli, 2012. "Monetary Transmission Mechanism and Time Variation in the Euro Area," Discussion Papers 12-12, Department of Economics, University of Birmingham.

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