Liquidity and Trading Dynamics

Abstract: In this paper, we build a model where the presence of liquidity constraints tends to magnify the economy’s response to aggregate shocks. We consider a decentralized model of trade, where agents may use money or credit to buy goods. When agents do not have access to credit and the real value of money balances is low, agents are more likely to be liquidity constrained. This makes them more concerned about their short-termearning prospects whenmaking their consumption decisions and about their short-term spending opportunities when making their production decisions. This generates a coordination element in spending and production which leads to greater aggregate volatility and greater comovement across producers.

Keywords: Liquidity, money, search, aggregate volatility, amplification.

Author(s): Veronica Guerrieri and Guido Lorenzoni

10 Guerrieri & Lorenzoni 2009.pdf