Liquidity effects and the monetary transmission mechanism
Several recent papers provide strong empirical support for the view that an expansionary monetary policy disturbance generates a persistent decrease in interest rates and a persistent increase in output and employment. Existing quantitative general equilibrium models, which allow for capital accumulation, are inconsistent with this view. There does exist a recently developed class of general equilibrium models which can rationalize the contemporaneous response of interest rates, output, and employment to a money supply shock. However, a key shortcoming of these models is that they cannot rationalize persistent liquidity effects. This paper discusses the basic frictions and mechanisms underlying this new class of models and investigates one avenue for generating persistence. We argue that once a simplified version of the model in Christiano and Eichenbaum (1991) is modified to allow for extremely small costs of adjusting sectoral flow of funds, positive money shocks generate long-lasting, quantitatively significant liquidity effects, as well as persistent increases in aggregate economic activity.
|Date of creation:||1992|
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- George A. Akerlof, 1979. "Irving Fisher on his Head: The Consequences of Constant Threshold-Target Monitoring of Money Holdings," The Quarterly Journal of Economics, Oxford University Press, vol. 93(2), pages 169-187.
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89-10, Federal Reserve Bank of Philadelphia.
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- 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.
- Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-34.
- Reichenstein, William, 1987. "The Impact of Money on Short-term Interest Rates," Economic Inquiry, Western Economic Association International, vol. 25(1), pages 67-82, January.
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