Liquidity effects, monetary policy, and the business cycle

Lawrence Christiano and Martin Eichenbaum

No 70, Discussion Paper / Institute for Empirical Macroeconomics from Federal Reserve Bank of Minneapolis

Abstract: This paper presents new empirical evidence to support the hypothesis that positive money supply shocks drive short-term interest rates down. We then present a quantitative, general equilibrium model which is consistent with this hypothesis. The two key features of our model are that (i) money shocks have a heterogeneous impact on agents and (ii) ex post inflexibilities in production give rise to a very low short-run interest elasticity of money demand. Together, these imply that, in our model, a positive money supply shock generates a large drop in the interest rate comparable in magnitude to what we find in the data. In sharp contrast to sticky nominal wage models, our model implies that positive money supply shocks lead to increases in the real wage. We report evidence that this is consistent with the U.S. data. Finally, we show that our model can rationalize a version of the Real Bills Doctrine in which the monetary authority accommodates technology shocks, thereby smoothing interest rates.

Keywords: Liquidity (Economics); Monetary policy; Business cycles (search for similar items in EconPapers)
Date: 1992
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Related works:
Journal Article: Liquidity Effects, Monetary Policy, and the Business Cycle (1995)
Working Paper: Liquidity effects, monetary policy and the business cycle (1992)
Working Paper: Liquidity Effects, Monetary Policy, and the Business Cycle (1992)
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