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Resolving the liquidity effect.

  • Economics


Resolving the Liquidity Effect H FYI 1W MAY/JUNE 1995 Adrian R. Pagan is a professor of economics at The Australian National University and the University aF Rochestet. John C. Robertson is a lecturer in econometrics at The Australian National University. The authors would like to especially thank Dan Thornton for his help in prepar- ing this article. Bill Lastrapes, Larry Christiano, Eric Leeper and David Longwarth have also given the authors valuable criticism and insight. All computations were performed using programs written in GAUSS v3.2.4. The programs and data are available on request through e-mail: [email protected] -01 Resolving the Liquidity Effect Adrian R. Pagan and John C. Robertson ‘Resolving: To separate into constituent or efemeiitary parts” (The Macquarie Dictionary) that excess money balances have a powerful direct influence on expenditures, conventional wisdom on the transmission mechanism of monetary policy has been that the effects are felt via interest rates. A very stylized view of this mechanism is available from the money demand and supply relations, which are either explicit or implicit in most models: (1) (2) = a + a2r~+ vn~=P1 +$2~0+~0 liçppthe effect on interest rates of a change in monetary policy has long been an impor- • cant topic in monetary economics, and there is now a large body of literature that has studied the existence and magnitude of any such effect. Strong conclusions have emerged, and yet, little is available by way of work that attempts to account for the diver- sity of conclusions. This article aims to fill some of this gap. As the title suggests, it does this by separating out the basic elements of the arguments that lead to the recorded con- clusions. In later sections, these are enumer- atedand discussed. The first section of the article sets out the framework underlying existing studies, followed by an examination of whether the proper object of investigation is a single relationship or a complete system.

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