Occasionally Binding Liquidity Constraints and Macroeconomic Dynamics

In this paper, I conduct a quantitative comparison upon different methodological treatments of a financial constraint. I compute two solutions to a version of the Kiyotaki and Moore (2012) RBC-model. In this framework, aggregate investment as well as the overall trading volume in the equity market must jointly satisfy a liquidity constraint. The tightness of this constraint depends on the aggregate state that particularly includes separate shocks to the resaleability of equity. One of the solutions is computed under the simplifying assumption that the constraint binds permanently, while the other one allows for an occasionally binding constraint. An inappropriate treatment of the constraint is leads to an artificial drop in the equity price. I report that this drop translates into long-run capital accumulation and implies substantial distortions in risky steady states, impulse responses and higher-order moments. Moreover, I find that the long-run comovement between liquidity and the equity price may turn from positive to negative, depending on the technical treatment of the constraint.