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Liquidity Shocks and the Business Cycle

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  • Bigio, Saki

    ()
    (Department of Economics, New York University)

Abstract

This paper studies the properties of an economy subject to random liquidity shocks. As in Kiyotaki and Moore [2008], liquidity shocks affect the ease with which equity can be used as to finance the down-payment for new investment projects. We obtain a liquidity frontier which separates the state-space into two regions (liquidity constrained and unconstrained). In the unconstrained region, the economy behaves according to the dynamics of the standard real business cycle model. Below the frontier, liquidity shocks have the effects of investment shocks. In this region, investment is under-efficient and there is a wedge between the price of equity and the real cost of capital. As with investment shocks, we argue that liquidity shocks are not an important source of business cycle fluctuations in absence of other frictions affecting the labor market.

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Bibliographic Info

Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2010-005.

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Date of creation: May 2010
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Handle: RePEc:rbp:wpaper:2010-005

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Related research

Keywords: Business Cycle; Asset Pricing; Liquidity;

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  1. CAMPANALE, Claudio & CASTRO, Rui & CLEMENTI, Gian Luca, 2009. "Asset Pricing in a Production Economy with Chew–Dekel Preferences," Cahiers de recherche 2009-09, Universite de Montreal, Departement de sciences economiques.
  2. Vasco Curdia & Michael Woodford, 2010. "Conventional and Unconventional Monetary Policy," Discussion Papers 0910-17, Columbia University, Department of Economics.
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Cited by:
  1. Vivek Prasad, 2014. "Balanced budget stimulus with tax cuts in a liquidity constrained economy," Birkbeck Working Papers in Economics and Finance 1401, Birkbeck, Department of Economics, Mathematics & Statistics.

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