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Liquidity effects, monetary policy and the business cycle

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  • Lawrence J. Christiano
  • Martin S. Eichenbaum

Abstract

This paper presents a flexible-price, quantitative general equilibrium model with the property that a positive money supply shock drives the nominal interest rate down, and aggregate employment, output, and the real wage up. These implications are broadly consistent with postwar U.S. data. The two key features of the model that are responsible for its properties are (1) money shocks have a heterogeneous impact on agents and (2) ex post inflexibilities in production give rise to a very low short-run interest elasticity of money demand. In our model, the extent of the drop in the interest rate after a positive money supply shock depends on the degree to which production is ex post inflexible. Given sufficient ex post inflexibility, the model conforms well with the view, widely held within the U.S. Federal System, that the short-run interest rate elasticity for total reserves is very close to zero. Copyright 1995 by Ohio State University Press.
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Suggested Citation

  • Lawrence J. Christiano & Martin S. Eichenbaum, 1992. "Liquidity effects, monetary policy and the business cycle," Working Paper Series, Macroeconomic Issues 92-15, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhma:92-15
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    References listed on IDEAS

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    Keywords

    Liquidity (Economics); Business cycles;

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