New Monetarist

A New Monetarist Model: Financial

Crises and Deficient Liquidity

Two classes of liquid assets in the

economy: currency and financial
liquid assets.
Financial liquid assets include
relatively safe assets that are widely-
traded in the financial system e.g.
government debt, bank reserves,
asset-backed securities.
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Financial Liquid Assets

Can be expressed as

B
a = + k (r )
P
B = nominal government debt.
k is a decreasing function of r, and k(r)
denotes financial liquid assets that are
produced in the private financial
system. e,g. more money available for
investment
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Financial Liquid Assets

Assume that, in the model, there can

be two possible states of the world:
adequate financial liquidity and
deficient financial liquidity.
Deficient financial liquidity occurs in a
financial crisis due to factors that
impair the ability of the financial sector
to create financial liquid assets.

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Modifying the Basic Monetary
Intertemporal Model

In the New Monetarist model,

financial liquid assets, a, have a
positive effect on output demand if
there is deficient financial liquidity.
(mostly through investment).
Given equilibrium in the money
market, BL(Y , r )
a= + k (r )
M
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New Effect in the New Monetarist
Model

An open market purchase (M goes

up, B goes down) shifts the output
demand curve to the left, if there is
deficient financial liquidity.

6
A Reduction in Financial Liquid Assets, Producing Deficient
Financial Liquidity

7
Monetary Policy Response to Deficient Financial Liquidity

8
Excess Reserves and the Liquidity
Trap

If reserves pay interest, as is the case

in Canada, and there is a positive
supply of reserves in the financial
system, then the interest rate on
reserves determines the market
interest rate.
Open market operations have no
effect.
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Excess Reserves and the Liquidity
Trap

Mr denotes reserve account balances,

Mc denotes currency
Now, re-define financial liquid assets
as:
( M r + B ) L(Y , r )
a= + k (r )
Mc

10
With Excess Reserves and a Liquidity Trap, an Increase
in the Interest Rate on Reserves is Beneficial

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 In the diagram depicts the conventional
case do r2 is less than r1-> what
Williamson is espousing is than if they
were to raise interest rate the Yd curve
would shift to the right thus increasing
output (GDP).