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Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach

  • Stephen D. Williamson

A model of public and private liquidity integrates financial intermediation theory with a New Monetarist monetary framework. Non-passive fiscal policy and costs of operating a currency system imply that an optimal policy deviates from the Friedman rule. A liquidity trap can exist in equilibrium away from the Friedman rule, and there exists a permanent nonneutrality of money, driven by an illiquidity effect. Financial frictions can produce a financial-crisis phenomenon that can be mitigated by conventional open market operations working in an unconventional manner. Private asset purchases by the central bank are either irrelevant or they reallocate credit and redistribute income. (JEL E13, E44, E52, E62, G01)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.102.6.2570
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 102 (2012)
Issue (Month): 6 (October)
Pages: 2570-2605

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Handle: RePEc:aea:aecrev:v:102:y:2012:i:6:p:2570-2605
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  1. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  2. Robert M. Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  3. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  4. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 159-179, September.
  5. repec:cto:journl:v:20:y:2001:i:3:p:452-465 is not listed on IDEAS
  6. Ricardo Lagos & Guillaume Rocheteau, 2006. "Money and capital as competing media of exchange," Working Paper 0608, Federal Reserve Bank of Cleveland.
  7. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  8. Benjamin Lester & Andrew Postlewaite & Randall Wright, 2011. "Information and Liquidity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 355-377, October.
  9. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  10. Ping He & Lixin Huang & Randall Wright, 2005. "Money And Banking In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, 05.
  11. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
  12. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
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