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BANKING, LIQUIDITY EFFECTS, AND MONETARY POLICY

Published online by Cambridge University Press:  23 January 2017

Te-Tsun Chang  and
Yiting Li
Te-Tsun Chang
Affiliation:
National Chi Nan University
Yiting Li*
Affiliation:
National Taiwan University
*
Address correspondence to: Yiting Li, Department of Economics, National Taiwan University, No. 1, Sec. 4, Roosevelt Road, 10617 Taipei, Taiwan; e-mail: yitingli@ntu.edu.tw.
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Abstract

We study liquidity effects and monetary policy in a model with fully flexible prices and explicit roles for money and financial intermediation. Banks hold some fractions of deposits and money injections as liquidity buffers. The higher the fraction kept as reserves, the less liquid the money is. Unexpected money injections raise output and lower nominal interest rates if and only if the newly injected money is more liquid than the initial money stocks. If banks hold no liquidity buffers, liquidity effects are eliminated. In an extended model with temporary shocks, we show that failure to withdraw state-contingent money injections does not make the stabilization policy neutral, though the economy may undergo higher short-run fluctuations than otherwise. Under this circumstance, the success of stabilization policy relies on unexpected money injections being more liquid than the initial money stock.

Keywords

Liquidity EffectsMoneyBankingMonetary Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 22 , Issue 5 , July 2018 , pp. 1267 - 1297
Copyright
Copyright © Cambridge University Press 2017 

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Footnotes

We thank two anonymous referees for comments and suggestions that substantially improved this paper. We also thank Jonathan Chiu, Kevin X.D. Huang, Young Sik Kim, and Shouyong Shi for helpful comments on the earlier draft of this paper and participants in the 2014 Econometric Society Asian Meetings in Taipei for helpful comments and conversations.

References

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