Liquidity, business cycles and monetary policy: A simulation

A Masters Thesis, presented as part of the requirements for the award of a Research Masters Degree in Economics from NOVA – School of Business and Economics

In Kiyotaki and Moore (2008) the authors develop a model in which di¤erences in the liquidity of distinct assets create a link between asset prices and macroeconomic aggregates. Their goal is to build a work- horse model that incorporates liquidity as the cause for the circulation of money, in a dynamic stochastic general equilibrium (DSGE) environment, close enough to the real business cycle (RBC) framework, and thus, suitable for studying monetary policy. In this article, I am interested in studying how this framework can be used to understand the e¤ects of liquidity and technology shocks in the U.S. economy. I calibrate their model and study the impact of adding up liquidity constraints on its RBC performance. I .nd that liquidity constraints have a remarkable impact on the volatility of investment and consumption. Moreover, I conclude that, in this context, asset prices. volatility is explained as a natural feature of a monetary economy when hit by liquidity shocks.