DP8511 Liquidity When It Matters Most: QE and Tobin?s q
|Author(s):||John Driffill, Marcus Miller|
|Publication Date:||August 2011|
|Keyword(s):||Credit Constraints, Liquidity Shocks, Temporary Equilibrium|
|JEL(s):||B22, E12, E20, E30, E44|
|Programme Areas:||International Macroeconomics, Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=8511|
How and why do financial conditions matter for real outcomes? The ?workhorse model of money and liquidity? of Kiyotaki and Moore (2008) shows how--with full employment maintained by flexible prices--shifting credit constraints can affect investment and future aggregate supply. We show that, when the flex-price assumption is dropped, an adverse but temporary liquidity shock can rapidly lead to Keynesian-style demand failure. Optimistic expectations may speed recovery, but simulation results suggest that prompt liquidity infusion by the central bank--i.e. Quantitative Easing--is needed to check prolonged recession.