Liquidity Effects and the Monetary Transmission Mechanism

15 Pages Posted: 3 Jul 2007  

Lawrence J. Christiano

Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Martin Eichenbaum

Northwestern University; National Bureau of Economic Research (NBER)

Date Written: January 1992

Abstract

Several recent papers provide strong empirical support for the view that an expansionary monetary policy disturbance generates a persistent decrease in interest rates and a persistent increase in output and employment. Existing quantitative general equilibrium models, which allow for capital accumulation, are inconsistent with this view. There does exist a recently developed class of general equilibrium models which can rationalize the contemporaneous response of interest rates, output, and employment to a money supply shock. However, a key shortcoming of these models is that they cannot rationalize persistent liquidity effects. This paper discusses the basic frictions and mechanisms underlying this new class of models and investigates one avenue for generating persistence. We argue that once a simplified version of the model in Christiano and Eichenbaum (1991) is modified to allow for extremely small costs of adjusting sectoral flow of funds, positive money shocks generate long-lasting, quantitatively significant liquidity effects, as well as persistent increases in aggregate economic activity.

Suggested Citation

Christiano, Lawrence J. and Eichenbaum, Martin, Liquidity Effects and the Monetary Transmission Mechanism (January 1992). NBER Working Paper No. w3974. Available at SSRN: https://ssrn.com/abstract=476135

Lawrence J. Christiano (Contact Author)

Northwestern University ( email )

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Federal Reserve Bank of Cleveland

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Federal Reserve Bank of Chicago

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Federal Reserve Bank of Minneapolis

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National Bureau of Economic Research (NBER)

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Martin Eichenbaum

Northwestern University ( email )

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United States
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847-491-7001 (Fax)

National Bureau of Economic Research (NBER)

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