Liquidity, Business Cycles, and Monetary Policy

By Nobuhiro Kiyotaki and John Moore

http://d.repec.org/n?u=RePEc:nbr:nberwo:17934&r=dge

The paper presents a model of a monetary economy where there are differences in liquidity across assets. Money circulates because it is more liquid than other assets, not because it has any special function. There is a spectrum of returns on assets, reflecting their differences in liquidity. The model is used, first, to investigate how aggregate activity and asset prices fluctuate with shocks to productivity and liquidity; second, to examine what role government policy might have through open market operations that change the mix of assets held by the private sector. With its emphasis on liquidity rather than sticky prices, the model harks back to an earlier interpretation of Keynes (1936), following Tobin (1969).

The latest Kiyotaki-Moore. Once more, they get us to think about the basics in an elegant way, this time in considering money as an asset like any other with the difference that it is more liquid in the sense that other assets need time to sell or buy. Money is then useful, despite its lack of nominal return, because of a “liquidity-in-advance” property of transactions. In a world where entrepreneurs need financing, having a central bank changing the amount of liquidity in the economy through open-market operations then matters, because it alters relative prices and because the central bank swap illiquid assets for liquid ones. And the economy is then better lubricated.

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