Liquidity Effects on Asset Prices Financial Stability and
Liquidity Effects on Asset Prices, Financial Stability and Economic Resilience by D. Tsomocos and J. F. Martinez A Discussion By Maxim Nikitin
The Main Idea of the Paper: • A dynamic stochastic general equilibrium model with endogenous liquidity and endogenous default • The main motivation: standard DSGE models abstract from endogenous default and do not allow for sudden shortages of liquidity that are so important in propagation of financial crises
Valuable Contribution, because • DSGE models used by central banks were developed during the “Great Moderation” when financial crises in major developed countries seemed no longer relevant (if not impossible).
A Negative Monetary Policy Shock • Raises interest rate and reduces the amount of liquidity in the system • Lowers the marginal cost of default • Increases the equilibrium level of default
However, it is hard to discuss the paper, because: The paper is a part a ‘multi-paper’ project, that Dimitrios is working on, the papers use similar framework, but the space limitations of a single paper do not allow him and his coauthor to present all the essential elements of the model and solution.
What can be done? • Have a complete version of the paper somewhere on the web (100+ pages, or whatever), that a person not familiar with their earlier works can read and understand. • Or write a book
Questions • Is this a “crisis-only” model, or is it descriptive model of the economy in both, tranquil and crisis times? • What are the shocks that cause financial crises? • What is the optimal policy (monetary and regulatory) response to these shocks?
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