Liquidity effects, the monetary transmission mechanism, and monetary policy
Lawrence J. Christiano , Martin Eichenbaum
In this article, we seek to accomplish three objectives. First, we discuss the basic mechanisms at work in these liquidity effect models. Second, we investigate one way of generating persistent (as opposed to purely transitory) liquidity effects. We argue that once a simplified version of the model in Christiano and Eichenbaum (1992a) is modified to allow for small costs of adjusting sectoral flows of funds, positive money supply shocks generate long lasting, significant liquidity effects as well as persistent increases in aggregate economic activity. Finally, we discuss some of the policy implications of this class of models.
