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

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  • 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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File URL: http://www2.uwrf.edu/RePEc/wrv/wpaper/cer1001.pdf
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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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  1. Logan Kelly, 2011. "The current stock of money: an aggregation theoretic measure of narrowly defined money," Applied Economics Letters, Taylor & Francis Journals, vol. 18(7), pages 659-664.
  2. Richard G. Anderson & Robert H. Rasche, 2000. "Retail sweep programs and bank reserves, 1994--1999," Working Papers 2000-023, Federal Reserve Bank of St. Louis.
  3. Sims, Christopher A, 1980. "Comparison of Interwar and Postwar Business Cycles: Monetarism Reconsidered," American Economic Review, American Economic Association, vol. 70(2), pages 250-57, May.
  4. Mishkin, Frederic S, 1982. " Monetary Policy and Short-Term Interest Rates: An Efficient Markets-Rational Expectations Approach," Journal of Finance, American Finance Association, vol. 37(1), pages 63-72, March.
  5. Nishiyama, Yasuo, 2011. "The term structure of CD rates and monetary policy transmission," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 82-94, January.
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues 94-2, Federal Reserve Bank of Chicago.
  7. Barnett, William A., 1980. "Economic monetary aggregates an application of index number and aggregation theory," Journal of Econometrics, Elsevier, vol. 14(1), pages 11-48, September.
  8. Nautz, Dieter & Schmidt, Sandra, 2009. "Monetary policy implementation and the federal funds rate," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1274-1284, July.
  9. Eric M. Leeper & David B. Gordon, 1991. "In search of the liquidity effect," International Finance Discussion Papers 403, Board of Governors of the Federal Reserve System (U.S.).
  10. Robert B. Litterman & Laurence M. Weiss, 1984. "Money, real interest rates, and output: a reinterpretation of postwar U.S. data," Staff Report 89, Federal Reserve Bank of Minneapolis.
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  12. Dutkowsky, Donald H & Cynamon, Barry Z, 2003. " Sweep Programs: The Fall of M1 and Rebirth of the Medium of Exchange," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(2), pages 263-79, April.
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  23. Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-34.
  24. Kelly, Logan J, 2008. "The Stock of Money and Why You Should Care," MPRA Paper 11455, University Library of Munich, Germany.
  25. Keen, Benjamin D., 2004. "In search of the liquidity effect in a modern monetary model," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1467-1494, October.
  26. Pierre-Richard Agénor & Karim El Aynaoui, 2008. "Excess Liquidity, Bank Pricing Rules, and Monetary Policy," Centre for Growth and Business Cycle Research Discussion Paper Series 105, Economics, The Univeristy of Manchester.
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  30. Eichenbaum, Martin & Evans, Charles L, 1995. "Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 110(4), pages 975-1009, November.
  31. Christopher A. Sims, 1992. "Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy," Cowles Foundation Discussion Papers 1011, Cowles Foundation for Research in Economics, Yale University.
  32. Serletis, A. & Chwee, V., 1997. "Resolving the Liquidity Puzzle," Papers 9707, Calgary - Department of Economics.
  33. Barnett, William A. & Liu, Yi & Jensen, Mark, 1997. "Capm Risk Adjustment For Exact Aggregation Over Financial Assets," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 485-512, June.
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Citations

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Cited by:
  1. El-Shagi, Makram & Kelly, Logan, 2013. "Liquidity in the Liquidity Crisis: Evidence from Divisia Monetary Aggregates in Germany and the European Crisis Countries," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79935, Verein für Socialpolitik / German Economic Association.
  2. Antonis Michis, 2011. "Multiscale Analysis of the Liquidity Effect," Working Papers 2011-5, Central Bank of Cyprus.
  3. 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.
  4. 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.
  5. 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.
  6. Kemal Bagzibagli, 2012. "Monetary Transmission Mechanism and Time Variation in the Euro Area," Discussion Papers 12-12, Department of Economics, University of Birmingham.
  7. 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.
  8. Paul, Sunil & Ramachandran, M., 2011. "Currency equivalent monetary aggregates as leading indicators of inflation," Economic Modelling, Elsevier, vol. 28(4), pages 2041-2048, July.

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