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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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Citations

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Cited by:
  1. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, Elsevier, vol. 33(C), pages 620-630.
  2. Makram El-Shagi & Sebastian Giesen & Logan J. Kelly, 2011. "The Quantity Theory Revisited: A New Structural Approach," IWH Discussion Papers, Halle Institute for Economic Research 7, Halle Institute for Economic Research.
  3. Makram El-shagi & Logan J Kelly, 2014. "Liquidity in the liquidity crisis: evidence from Divisia monetary aggregates in Germany and the European crisis countries," Economics Bulletin, AccessEcon, vol. 34(1), pages 63-72.
  4. Makram El-Shagi & Sebastian Giesen & Logan J. Kelly, 2012. "Monetary Policy in a World Where Money (Also) Matters," IWH Discussion Papers, Halle Institute for Economic Research 6, Halle Institute for Economic Research.
  5. John Keating & Logan J. Kelly & Andrew Lee Smith & Victor J. Valcarcel, 2014. "A Model of Monetary Policy Shocks for Financial Crises and Normal Conditions," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS, University of Kansas, Department of Economics 201401, University of Kansas, Department of Economics.
  6. Kemal Bagzibagli, 2012. "Monetary Transmission Mechanism and Time Variation in the Euro Area," Discussion Papers, Department of Economics, University of Birmingham 12-12, Department of Economics, University of Birmingham.
  7. Antonis Michis, 2011. "Multiscale Analysis of the Liquidity Effect," Working Papers, Central Bank of Cyprus 2011-5, Central Bank of Cyprus.
  8. Paul, Sunil & Ramachandran, M., 2011. "Currency equivalent monetary aggregates as leading indicators of inflation," Economic Modelling, Elsevier, Elsevier, vol. 28(4), pages 2041-2048, July.

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