Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore

Discussion on “Liquidity, Business Cycles, andMonetary Policy”
by Nobu Kiyotaki and John Moore
Discussant: Zheng Liu
Federal Reserve Bank of San Francisco1

May 27, 20091

The views expressed here do not necessarily reflect the views of the Federal

Reserve Bank of San Francisco or the Federal Reserve System.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Summary
I Liquidity constraints give rise to (precautionary) demand formoney and liquidity premia.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Summary
I Liquidity constraints give rise to (precautionary) demand formoney and liquidity premia.
I Two-way interactions between asset prices and aggregate

quantities: different from standard RBC models and standard
finance models

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Summary
I Liquidity constraints give rise to (precautionary) demand formoney and liquidity premia.
I Two-way interactions between asset prices and aggregate

quantities: different from standard RBC models and standard
finance models
I By exchanging money for equity, the unconventional monetary

policy can alleviate liquidity shocks and expand investment;
but conventional monetary policy is neutral.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Comments

I Empirical implications: two-way interactions between asset

prices and aggregate quantities can be a potentially powerfultransmission mechanism for business cycle shocks
I Policy implications: it matters what kind of assets toexchange (treasury bills or equity) in open market operations.
It’s a great paper that will influence the thinking of academics andpolicymakers in years to come.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Discussions
I Are we ready to use the framework, with some additional

fleshes and muscles, to guide monetary policy making, orperhaps to replace the dynamic sticky-price models?

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Discussions
I Are we ready to use the framework, with some additional

fleshes and muscles, to guide monetary policy making, orperhaps to replace the dynamic sticky-price models?
I To answer this question, two sets of issues need to beaddressed:

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Discussions
I Are we ready to use the framework, with some additional

fleshes and muscles, to guide monetary policy making, or
perhaps to replace the dynamic sticky-price models?
I To answer this question, two sets of issues need to beaddressed:
1. An empirical issue: Are the liquidity constraints quantitatively
important in shaping business cycles?

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Discussions
I Are we ready to use the framework, with some additional

fleshes and muscles, to guide monetary policy making, orperhaps to replace the dynamic sticky-price models?
I To answer this question, two sets of issues need to beaddressed:
1. An empirical issue: Are the liquidity constraints quantitatively
important in shaping business cycles?
2. A policy issue: To what extent does monetary policy (esp.
unconventional policy) affect the real economy?

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Quantitative importance of liquidity constraints
I Some have argued that liquidity constraints are not effectivein amplifying TFP shocks (Kocherlakota (2000), Cordoba andRipoll (2004)).

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Quantitative importance of liquidity constraints
I Some have argued that liquidity constraints are not effectivein amplifying TFP shocks (Kocherlakota (2000), Cordoba andRipoll (2004)).
I Recent work by Liu, Wang, and Zha (LWZ, 2009) shows thatinteractions between asset prices and aggregate quantities arequantitatively important.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Quantitative importance of liquidity constraints
I Some have argued that liquidity constraints are not effectivein amplifying TFP shocks (Kocherlakota (2000), Cordoba andRipoll (2004)).
I Recent work by Liu, Wang, and Zha (LWZ, 2009) shows thatinteractions between asset prices and aggregate quantities arequantitatively important.
I The key is to have some shocks that move the asset prices.

While TFP shock does not move asset prices much, someother shocks do (see Figure).

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Contributions of housing demand shock in the LWZ modelLand Prices

0.2
0Consumption

−0.2
1975

1980

1985

1990

1995

2000

2005

2010

1980

1985

1990

1995

2000

2005

2010

1980

1985

1990

1995

2000

2005

2010

0.05
0−0.051975
Investment0.2
0−0.2
1975

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Policy issues
I Since the conventional policy is neutral, the Fed policy did notcontribute much to the Great Moderation.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Policy issues
I Since the conventional policy is neutral, the Fed policy did notcontribute much to the Great Moderation.
I Is the unconventional policy important for business cycles? It

can be. Financial interdependence (e.g., credit chains) canfurther strengthen the real effects of monetary policy.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Policy issues
I Since the conventional policy is neutral, the Fed policy did notcontribute much to the Great Moderation.
I Is the unconventional policy important for business cycles? Itcan be. Financial interdependence (e.g., credit chains) canfurther strengthen the real effects of monetary policy.
I Caution: The expectation effects of regime switching can beimportant (Liu, Waggoner, and Zha (2009)).

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Policy issues
I Since the conventional policy is neutral, the Fed policy did notcontribute much to the Great Moderation.
I Is the unconventional policy important for business cycles? It

can be. Financial interdependence (e.g., credit chains) canfurther strengthen the real effects of monetary policy.
I Caution: The expectation effects of regime switching can beimportant (Liu, Waggoner, and Zha (2009)).
I Current situations: Do Fed policies help alleviate impairedliquidity (without raising inflation expectations)?

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Looking ahead...

I Important subject of research: to assess the empiricalperformance of the liquidity business cycle (LBC) model.

Discussion on “Liquidity, Business Cycles, and Monetary Policy” by Nobu Kiyotaki and John Moore
Overview

Looking ahead...

I Important subject of research: to assess the empiricalperformance of the liquidity business cycle (LBC) model.
I Should consider replacing the RBC core with the more

promising LBC core in a new generation of DSGE models forpolicy analysis.