Liquidity and Economic Fluctuations

Abstract

This paper shows that private information may be crucial in explaining the relationship between liquidity, investment and economic fluctuations. First, it defines liquidity in a way that is clearly connected to investment and output. Second, it models economies where privately informed entrepreneurs issue debt to fund their investment opportunities and identifies a theoretically based, empirically usable, and macroeconomic relevant measure of liquidity of the economy: the cross-firm dispersion in debt yields. Finally, it rationalizes one novel stylized fact regarding the US corporate bond market: the positive relationship between the proposed meaure of liquidity - the cross-firm dispersion in the "yields to maturity" on newly issued publicly traded debt - and subsequent aggregate economic activity.Liquidity; private information; robust pooling equilibrium; bond yield