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Liquidity Effects and Market Frictions

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  • Hendry, Scott
  • Zhang, Guang-Jia

Abstract

The goal of this paper is to shed light on the nature of the monetary transmission mechanism. Specifically, we attempt to tackle two problems in standard limited-participation models: (1) the interest rate liquidity effect is not as persistent as in the data; and (2) some nominal variables are unrealistically volatile. To address these problems, we introduce nominal wage and price rigidities, as well as portfolio adjustment costs and monopolistically competitive firms, to better understand how each of these costs affects the size and length of the liquidity effect following a central-bank policy action. Quantitative analysis shows that including these rigidities does improve the model, to some extent at least, in the expected manner. The main findings are: (1) wage and portfolio adjustment costs are able to deepen and lengthen the liquidity effect following a monetary policy action; (2) these two adjustment costs, especially wage adjustment costs, can reduce inflation volatility; (3) price adjustment costs, at least under money-growth policy rules, cause excessive interest-rate volatility and are unable to significantly reduce inflation volatility.
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  • Hendry, Scott & Zhang, Guang-Jia, 2001. "Liquidity Effects and Market Frictions," Journal of Macroeconomics, Elsevier, vol. 23(2), pages 153-176, April.
    • Handle: RePEc:eee:jmacro:v:23:y:2001:i:2:p:153-176
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    2. Peter Ireland & Niki Papadopoulou, 2004. "Sticky Prices vs Limited Participation: What do we Learn from the Data?," Working Papers 2004_4, Business School - Economics, University of Glasgow.
    3. Karamé, Frédéric & Patureau, Lise & Sopraseuth, Thepthida, 2008. "Limited participation and exchange rate dynamics: Does theory meet the data?," Journal of Economic Dynamics and Control, Elsevier, vol. 32(4), pages 1041-1087, April.
    4. Dib, Ali, 2006. "Nominal rigidities and monetary policy in Canada," Journal of Macroeconomics, Elsevier, vol. 28(2), pages 303-325, June.
    5. Stracca, Livio, 2001. "Does liquidity matter? Properties of a synthetic divisia monetary aggregate in the euro area," Working Paper Series 79, European Central Bank.
    6. David Longworth & Brian O´Reilly, 2002. "The Monetary Policy Transmission Mechanism and Policy Rules in Canada," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 13, pages 357-392, Central Bank of Chile.
    7. David Laidler, 1999. "The Quantity of Money and Monetary Policy," Staff Working Papers 99-5, Bank of Canada.
    8. Patureau, Lise, 2007. "Pricing-to-market, limited participation and exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3281-3320, October.
    9. Stracca, Livio, 2001. "Does liquidity matter? Properties of a synthetic divisia monetary aggregate in the euro area," Working Paper Series 0079, European Central Bank.
    10. Shamik Dhar & Stephen P Millard, 2000. "A limited participation model of the monetary transmission mechanism in the United Kingdom," Bank of England working papers 117, Bank of England.
    11. Niki Papadopoulou, 2004. "Sticky Prices, Limited Participation or Both?," Working Papers 2004_3, Business School - Economics, University of Glasgow.
    12. Anders Richtnér & Pär Åhlström, 2006. "Influences On Organisational Slack In New Product Development Projects," International Journal of Innovation Management (ijim), World Scientific Publishing Co. Pte. Ltd., vol. 10(04), pages 375-406.
    13. Lishun Zeng & Shinji Mizuno, 2013. "On The Generalized Mirrored Scheme For Double Round Robin Tournaments In Sports Scheduling," Asia-Pacific Journal of Operational Research (APJOR), World Scientific Publishing Co. Pte. Ltd., vol. 30(03), pages 1-16.
    14. Niki Papadopoulou, 2006. "Sticky Prices vs. Limited Participation:What Do We Learn From the Data?," Computing in Economics and Finance 2006 418, Society for Computational Economics.
    15. Chung, Kyuil, 2009. "Does the liquidity effect guarantee a positive term premium?," Economic Modelling, Elsevier, vol. 26(5), pages 893-903, September.
    16. Shamik Dhar & Stephen P Millard, 2000. "How well does a limited participation model of the monetary transmission mechanism match UK data?," Bank of England working papers 118, Bank of England.
    17. Auray, Stéphane, 2009. "Consommation, effet de substitution intertemporelle et formation des habitudes," L'Actualité Economique, Société Canadienne de Science Economique, vol. 85(4), pages 437-473, décembre.

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    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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