When money matters: liquidity shocks with real

Transcript:When money matters: liquidity shocks with real:
When money matters: liquidity shocks with real effects John Driffill and Marcus Miller Birkbeck and University of Warwick 1 Financial boom… (Note: US GDP is about $14 trillion) 2 Followed by bust: UK recession (dark blue) relative to earlier recessions (dark brown is 1930s; green and yellow follow oil shocks; light brown follows bursting of housing bubble:) 3 Call for integration of financial factors into real models In ‘The Great Moderation, the Great Panic and the Great Contraction’ Charlie Bean (2009) calls for further research on financial factors as an urgent priority. In fact, Kiyotaki and Moore (2008) have developed a ‘workhorse model of money and liquidity’ where liquidity constraints can affect investment and the economy. With flex-prices and full employment, their focus is on the supply side. Simulations of such a model by FRBNY- in conjunction with Kiyotaki - in a fix-price environment produce dramatic results for liquidity shocks for aggregate demand. Background: growth and investment Before considering how financial factors may affect investment, we look at three real models of capital accumulation The simplified Solow model of growth Neoclassical optimising model Tobin’s q –theory of investment Reference Acemoglou, Daron. Introduction to Modern Economic Growth. Princeton Univ Press 5 Effect of a liquidity shock in US that lasts 10 quarters, Del Negro et al. (2009) – with analytical equivalent from Driffill and Miller (2010) DM 6 The Simple Solow Growth Model (with Fixed Technology and Exponential Depreciation) 7 Neoclassical growth model: high marginal productivity of capital encourages savings c f´(k * )=θ y, output per head k* k, capital per head k° = 0 c, consumption per head k(o) c° = 0 8 The q-theory of Investment and Saddle-Path stability 9 Dynamics of K and q: phase diagram q Equity Price K Capital Stock S U K* Zero net investment Asset price stationary U S K°= 0 q°= 0 K(0) E 10 Kiyotaki and Moore (2008): “Liquidity, Business Cycles, and Monetary Policy” Assets involved: Money and equity Money is liquid Equity is not (completely) liquid only a fraction of holdings can be sold each period only a fraction of newly produced capital goods can be financed by issuing new equity Workers – not the focus of attention Rational and forward-looking, but credit constrained (no borrowing) Do not have ‘ideas’ for investment Can hold money and equity if they choose But choose to spend all they get on consumption and