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

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Author Info

  • Logan Kelly

    ()
    (University of Wisconsin, Department of Economics, River Falls, WI 54022)

  • William Barnett

    ()
    (University of Kansas, Department of Economics, Lawrence, KS 66045)

  • John Keating

    ()
    (University of Kansas, Department of Economics, Lawrence, KS 66045)

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 UWRF - Center for Economic Research, College of Business and Economics, University of Wisconsin - River Falls in its series Working Papers in Economics and Finance with number 1001.

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Length: 28 pages
Date of creation: Apr 2010
Date of revision:
Handle: RePEc:wrv:wpaper:1001

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Phone: 425-3991
Fax: 425-3536
Web page: http://www.uwrf.edu/cer
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Keywords: North-South; growth model; innovation assimilation;

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References

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Citations

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Cited by:
  1. Paul, Sunil & Ramachandran, M., 2011. "Currency equivalent monetary aggregates as leading indicators of inflation," Economic Modelling, Elsevier, vol. 28(4), pages 2041-2048, July.
  2. 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.
  3. Muhanji, Stella & Malikane, Christopher & Ojah, Kalu, 2013. "Price and liquidity puzzles of a monetary shock: Evidence from indebted African economies," Economic Modelling, Elsevier, vol. 33(C), pages 620-630.
  4. John Keating & Logan Kelly & Andrew Lee Smith & Victor J. Valcarcel, 2014. "A Model of Monetary Policy Shocks for Financial Crises and Normal Conditions," Working Papers in Economics and Finance 1002, UWRF - Center for Economic Research, College of Business and Economics, University of Wisconsin - River Falls.
  5. 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.
  6. 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.
  7. Antonis Michis, 2011. "Multiscale Analysis of the Liquidity Effect," Working Papers 2011-5, Central Bank of Cyprus.
  8. 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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