Transcript Discussion of Kiyotaki & Moore „Liquidity

Discussion of Kiyotaki & Moore
„Liquidity, Business Cycles, and Monetary Policy“
Gerhard Illing
LMU Munich University/CESifo
Banque de France – Bundesbank conference
June 2009
Central issues
• A role for liquid assets in a RBC model
motivated by real frictions
• Strength: Model response of output and asset
prices to liquidity shocks
Characterize aggregate fluctuations in an
economy with real frictions; role for monetary
policy to smooth fluctuations
• Skepticism: Does the model really help to
understand the role of monetary policy in normal
times or in times of stress?
Summary – Model setup
•
•
•
Economy with heterogeneous agents.
Workers are passive (needed as tax base)
Entrepreneurs have stochastic investment opportunities
– New capital needs to be funded: need to issue equity
– Limited commitment:
(1) Borrowing constraint: Productive entrepreneurs can
finance only a fraction θ<1 with external funds
(2) Resale-ability constraint: Only fraction φ<1 of equity
can be resold each period!  Liquidity constraint
Motivates a role for fiat money with dominated return:
Potentially productive entrepreneurs prefer to hold a mix of
liquid money and high yielding, yet illiquid equity claims
Summary – The main insights
• Productive entrepreneurs invest every penny –
Binding liquidity constraint; no money holding;
• Unproductive entrepreneurs hold a portfolio mix
with money and equity. Trade off:
– Chance to become productive
— Money is most liquid asset to finance investment
– Risk to stay unproductive
— Equity holdings yield higher return.
• Beautiful fairy tale: Elegant modeling of aggregate
dynamics with heterogeneous agents; explicit
closed form solution
Derives some Keynesian features (Feedback between
goods and asset market; Tobin’s Q) in a tractable dynamic
general equilibrium model
Summary – The main insights
• What happens after a liquidity shock?
– φ falls
– Productive entrepreneurs can get less funds by selling
equity  Equity less attractive among unproductive
entrepreneurs
– Falling asset price, rising value of money (flight to
liquidity, deflation)
– Falling investment
– Rising consumption; decumulation of capital
–…
Summary – The main insights
Monetary policy? Open market operation:
Buy (sell) equity by issuing (withdraw) money
– Inefficiency of laissez-faire monetary economy:
Consumption is not smooth.
Policy response after a negative shock on φ:
– Open market operation to increase the liquidity of the
investing entrepreneurs, so
– Investments and asset prices can be insulated from
the liquidity shock,
– Helps to smooth consumption!
Comments
Optimal monetary policy: Implement Friedman rule to
eliminate the frictions from liquidity constraints
 Implement first best outcome
• Trust in money (government) substitutes for lack of trust
in entrepreneurs. Why?
Problem 1: Model does not respect Lucas critique
• Frictions (Borrowing and Resale-ability constraints) do
not respond to policy changes
• Moral hazard of entrepreneurs may be affected by
policy: Need to model the frictions from first principles to
define the set of constrained efficient outcomes.
• Exogenous variations of θ and φ: Is a change in φ
simply a change in belief?
• Cheap route: Ability to tax workers makes liquidity
constraints of entrepreneurs non-binding
Comments
Problem 2: Model is biased towards favoring central
bank intervention
• Frictions θ, φ distort economy away from efficient
outcome in just one direction: under-accumulation!
Central bank intervention helps to smooth/ overcome
frictions.
Does not capture a key element of current debate.
Model cannot address the notion of “Fool’s Gold”
(Overinvestment; excessive risk taking)
Allow for possibility of Ponzi or Madoff games (φ>1?)
Comments
Alan Greenspan, Speech on Consumer Finance April 2005
θ 1; φ1
“With these advances in technology, lenders have taken
advantage of credit-scoring models and other techniques for
efficiently extending credit to a broader spectrum of
consumers. … Where once more-marginal applicants would
simply have been denied credit, lenders are now able to
quite efficiently judge the risk posed by individual
applicants and to price that risk appropriately. These
improvements have led to rapid growth in subprime
mortgage lending“
Are recent times of stress just
a temporary shock in the perception of φ?
Conclusion
• A compact, tractable framework to introduce a
role for liquidity in standard RBC type models.
• Beautiful framework.
• But much more needs to be done!