Asset supply and liquidity transformation at Lietuvos Central Bank

Asset supply and liquidity transformation at Lietuvos Central Bank

In this project, we focus on the role of the liquid asset market in shaping the response to macroeconomic shocks and policies. That is the market where monetary policy takes place, and fiscal policy gets financing. It plays a key role for households, as they need to accumulate liquid assets to insure against adverse income shocks. Last but not least, that is where banks issue deposits and fund investments in various illiquid assets (capital, housing). We find that in a large class of models of financial frictions, liquid asset supply can be summarized by two key elasticities: cross-price and own-price. The own-price elasticity matters for the effects of monetary policy, the cross-price elasticity matters for the general equilibrium amplifications of various shocks and policies. When there is a shift in excess demand for liquid assets (for example, induced by a change in households' income or by an increase in the stock of government debt), it's the cross-price elasticity that governs the size of the necessary adjustment in the real rate of return on capital. We show the role of these two elasticities both theoretically and in a quantitative model calibrated to match the U.S. economy. 

Slides are available below. All comments are appreciated. 

 

20/Sep/2022
Gedimino pr. 6, Vilnius