Financial Crisis and Recovery: Learning-based Liquidity Preference Fluctuations

Ryo Horii () and Yoshiyasu Ono

Macroeconomics from EconWPA

Abstract: This paper examines a mechanism of liquidity-preference fluctuations caused by people's learning behavior. % about the frequency of a liquidity shock. When observing a financial shock, they rationally update their belief so that the subjective probability of encountering it again is higher, immediately raise liquidity preference and reduce consumption. As a period without the shock lasts after that, they gradually decrease the subjective probability, lower liquidity preference and increase consumption. Particularly, when the shock is observed many times in succession, recovery is first slow because people do not easily change their pessimistic view, then gradually accelerates, and eventually slows down as they become fully optimistic.

Keywords: Bayesian Learning; Liquidity Preference; Precautionary Motive; Markov Switching (search for similar items in EconPapers)
JEL-codes: D83 E41 E32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: Written 2005-04-12
Note: Type of Document - pdf; pages: 37
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