Liquidity When It Matters Most: QE and Tobin's Q

Driffill, John; Miller, Marcus H.

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Liquidity When It Matters Most: QE and Tobin's Q

CEPR Discussion Paper No. DP8511

40 Pages Posted: 12 Aug 2011

See all articles by John Driffill

Marcus H. Miller

University of Warwick - Department of Economics; Institute for International Economics; Centre for Economic Policy Research (CEPR)

Date Written: August 2011

Abstract

How and why do financial conditions matter for real outcomes? The workhorse model of money and liquidity of Kiyotaki and Moore (2008) shows how - with full employment maintained by flexible prices - shifting credit constraints can affect investment and future aggregate supply. We show that, when the flex-price assumption is dropped, an adverse but temporary liquidity shock can rapidly lead to Keynesian-style demand failure. Optimistic expectations may speed recovery, but simulation results suggest that prompt liquidity infusion by the central bank - i.e. Quantitative Easing - is needed to check prolonged recession.

Keywords: Credit Constraints, Liquidity Shocks, Temporary Equilibrium

JEL Classification: B22, E12, E20, E30, E44

Suggested Citation: Suggested Citation

Driffill, John and Miller, Marcus H., Liquidity When It Matters Most: QE and Tobin's Q (August 2011). CEPR Discussion Paper No. DP8511, Available at SSRN: https://ssrn.com/abstract=1908559