THE EFFECTS OF NEWS WHEN LIQUIDITY MATTERS

Chao Gu, Han Han and Randall Wright

International Economic Review, 2020, vol. 61, issue 4, 1411-1435

Abstract: We analyze the impact of news (information shocks) in economies where liquidity matters, including those with endogenous credit limits, and those with assets serving as collateral or media of exchange. Although we also consider news about productivity and credit conditions, a leading case concerns monetary policy announcements. Real or monetary news has big effects on markets, potentially causing cyclic or boom–bust responses, even though we focus on the unique transition consistent with stationarity after shocks. In particular, policy announcements may induce instead of reduce volatility. We also discuss the implications for the inflation puzzle, forward‐guidance puzzle, and other apparent anomalies.

Date: 2020
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