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Liquidity Shocks and the Business Cycle

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Listed author(s):
  • Bigio, Saki

    ()

    (Department of Economics, New York University)

Abstract

This paper studies the properties of an economy subject to random liquidity shocks. As in Kiyotaki and Moore [2008], liquidity shocks affect the ease with which equity can be used as to finance the down-payment for new investment projects. We obtain a liquidity frontier which separates the state-space into two regions (liquidity constrained and unconstrained). In the unconstrained region, the economy behaves according to the dynamics of the standard real business cycle model. Below the frontier, liquidity shocks have the effects of investment shocks. In this region, investment is under-efficient and there is a wedge between the price of equity and the real cost of capital. As with investment shocks, we argue that liquidity shocks are not an important source of business cycle fluctuations in absence of other frictions affecting the labor market.

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File URL: http://www.bcrp.gob.pe/docs/Publicaciones/Documentos-de-Trabajo/2010/Documento-de-Trabajo-05-2010.pdf
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Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2010-005.

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Date of creation: May 2010
Handle: RePEc:rbp:wpaper:2010-005
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Keywords: Business Cycle; Asset Pricing; Liquidity;

Find related papers by JEL classification:

  • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
  • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
  • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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  1. Vasco Cúrdia & Michael Woodford, 2010. "Conventional and unconventional monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 229-264.
  2. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2007. "Business Cycle Accounting," Econometrica, Econometric Society, vol. 75(3), pages 781-836, 05.
  3. Claudio Campanale & Rui Castro & Gian Luca Clementi, 2010. "Asset Pricing in a Production Economy with Chew-Dekel Preferences," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(2), pages 379-402, April.
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Cited by:

  1. Luigi Bocola, 2014. "The Pass-Through of Sovereign Risk," 2014 Meeting Papers 1286, Society for Economic Dynamics.
  2. Vivek Prasad, 2014. "Balanced budget stimulus with tax cuts in a liquidity constrained economy," Birkbeck Working Papers in Economics and Finance 1401, Birkbeck, Department of Economics, Mathematics & Statistics.

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