A macroeconomic investigation of funding liquidity and monetary policy shocks in the United States

Abstract

This article provides empirical evidence that aggregate funding liquidity shocks and monetary policy shocks contribute to the business cycles in the United States. I estimate a structural VAR model with monthly macro-financial data, and identify the structural shocks based on the recursiveness assumption. Both adverse funding liquidity and monetary policy shocks, which are orthogonal to each other by construction, cause significant recessions, with monetary policy shocks generating relatively deeper and longer recessionary effects. Only funding liquidity shocks significantly reduce market liquidity. These two shocks account for over 30% of the cyclical fluctuations of the unemployment rate and industrial production two years after the shocks hit.

Keywords:

• funding liquidity
• monetary policy
• business cycles
• VAR

JEL Classification:

• C32
• E32

Notes

¹ As robustness checks, I also include real oil prices, real stock returns and the implied stock market volatility in the system. None of the major results presented in this article is significantly altered.