The Distribution of Optimal Liquidity for Economic Growth and Stability

44 Pages Posted: 4 Jun 2016

See all articles by Hak K. PYO

Hak K. PYO

Korea Institute for International Economic Policy

Saerang Song

University of Wisconsin - Madison

Date Written: December 28, 2015

Abstract

This research paper intends to redefine and extend the concept of 'optimal liquidity' discussed in Han and Lee (2012). For this purpose, we have distinguished between liquidity held by households and liquidity held by firms following Levhari and Patinkin (1968) and Yoo and Pyo (1986). Han and Lee (2012) have revised the 'money-in-utility' model by Walsh (2012) and derived the relationship between liquidity and consumption. In the present paper, we have extended Han and Lee (2012) to a 'money-in-utility-and-production' model. We have specified a DSGE model in which liquidity serves for both household utility and production input and have conducted the impulse-response analysis. The impulse-responses of most of important variables from the shock of TFP increase are consistent with the results of Bhattacharjee and Thoenissen (2007). On the other hand, the policy interest rate shows a hump-shaped impulse-response, which is consistent with the impulse response of monetary expansion in the cash-in-advance model. In addition, the increase in money supply has produced a kind of crowding-out effect reducing the share of liquidity held by firms. The main policy implication of our model is that not only the absolute level of optimal liquidity but also the relative distribution of the liquidity between households and firms are important determinant for economic growth and stability. In order to validate this proposition, we have conducted a panel regression analysis and have empirically verified the proposition that the relatively higher share of liquidity held by firms would contribute to both GDP growth and its stability.

Keywords: Monetary Policy, Liquidity, DSGE, Panel Regression

JEL Classification: C32, E23, E40

Suggested Citation

PYO, Hak K. and Song, Saerang, The Distribution of Optimal Liquidity for Economic Growth and Stability (December 28, 2015). KIEP Research Paper No. Working Papers-15-02. Available at SSRN: https://ssrn.com/abstract=2773354 or http://dx.doi.org/10.2139/ssrn.2773354

Hak K. PYO (Contact Author)

Korea Institute for International Economic Policy ( email )

[30147] Building C, Sejong National Research Compl
Seoul, 370
Korea, Republic of (South Korea)

Saerang Song

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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