Turnover Liquidity and the Transmission of Monetary Policy

Abstract

At least one co-author has disclosed a financial relationship of potential relevance for this research. Further information is available online at http://www.nber.org/papers/w25106.ack NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

Economics with Market Liquidity Risk

“…Market liquidity varies systematically over the business cycle (Naes, Skjeltorp, and Ødegaard (2011)) and several theories seek to incorporate financial frictions into models of the macroeconomy (see Brunnermeier, Eisenbach, and Sannikov (2013) for a survey, or Cui and Radde (2016) for a recent searchbased model). Liquidity can affect the transmission of monetary policy (Lagos and Zhang (2018)).…”

A Monetary Model of Bilateral Over-the-Counter Markets

“…Since the number of transactions in the OTC market is small, the illiquidity measure constructed from transaction data may respond with delay. Although monetary policy in the model we presented above is deterministic, one could extend the theory to allow for random monetary policy shocks as in Lagos and Zhang (2018). The key result that unexpected tightening of monetary policy lowers the asset price and increases market illiquidity also holds in the stochastic formulation.…”

Private and public liquidity provision in over‐the‐counter markets

“…Some studies have explored the role of endogenous market liquidity by considering the cost of secondary market participation (Shi 2015, Bruche and Segura 2017, Cui and Radde 2019) or endogenous asset issuance (Geromichalos and Herrenbrueck 2016b, Bethune et al 2019). Other studies consider the effect of monetary policy on trade frictions by changing agents' money holdings used in decentralized exchange (Lagos and Wright 2005, Lagos and Zhang 2020 among others). Our focus is different.…”