Understanding a New Keynesian Model with Liquidity

The Global Financial Crisis of 2007--2009 and its aftermath have called for a rethink the role money in shaping business cycle fluctuations. To this end, paper studies New Keynesian model with (liquidity). In model, agents hold government other financial assets. However, there is short rate disconnect (i.e., an interest spread) between policy on household's savings. shows that exists meaningful liquidity effect quantitatively significant macroeconomy. As spread increases, so does price liquidity. where consumption are complements, such increase opportunity cost induces to consume less work less. Both effects imply real wage can fall, which turn puts downward pressures inflation via Phillips curve. fall makes monetary authority cut nominal rates by more, but at increasing even further. addition, compares dynamic responses technology shocks standard model. results show be different two models. Finally, interaction policy, highlighting play cycles.