Concerns about both the level of bond market liquidity and its fragility have risen lately, prompted partly by events such as the October 2014 Treasury bond flash rally in the US, or the April 2015 Bund tantrum in Europe. This column assesses current market liquidity and resilience, discerning several key policy recommendations from the evidence.
Luis Brandao-Marques, Gaston Gelos, 18 January 2016
Nina Karnaukh, Angelo Ranaldo, Paul Söderlind, 10 September 2015
Understanding foreign exchange markets is key to understanding the global financial system. Yet, a clear understanding of why and how foreign exchange illiquidity materialises is still missing. This column suggests that foreign exchange liquidity can be impaired in times of flight to quality and higher global risk, and that commonality increases in distressed markets.
Antonio Acconcia, Giancarlo Corsetti, Saverio Simonelli, 14 August 2015
Fiscal transfers are successful in stimulating aggregate demand to the extent that they reach households with a high marginal propensity to consume. Using micro evidence from Italian earthquakes, this column argues that a well-designed programme of temporary transfers, targeted to relatively wealthy but possibly illiquid households, can be quite helpful in speeding up recovery.
Bastian von Beschwitz, Donald B. Keim, Massimo Massa, 02 July 2015
High-frequency news analytics can increase market efficiency by allowing traders to react faster to new information. One concern about such services is that they might provide a competitive advantage to their users with potential distortionary price effects. This column looks at how high frequency news analytics affect the stock market, net of the informational content that they provide. News analytics improve price efficiency, but at the cost of reducing liquidity and with potentially distortionary price effects.
Clemens Jobst, Stefano Ugolini, 23 June 2015
Central banks today provide liquidity exclusively through purchases of (mostly) government bonds and through collateralised open-market operations. This column considers the evolution of liquidity provision by central banks over the past two centuries, and argues that there are alternative approaches to those that are focused on today. One such alternative is a revival of the 19th century practice of uncollateralised lending. This would discourage market participants from relying on informational shortcuts, and reduce the likelihood that informational shocks trigger collateral crises.
Philippe Bacchetta, Kenza Benhima, Céline Poilly, 19 February 2015
The corporate cash ratio – the share of liquid assets in total assets – comoves with employment in the US. This column argues that disentangling liquidity shocks and credit shocks is key to understanding this comovement, and that liquidity shocks appear to be crucial. These shocks make production less attractive or more difficult to finance, while they also generate a need for internal liquidity to pay wages, which can be satisfied by holding more cash.
Philippe Karam, Ouarda Merrouche, Moez Souissi, Rima Turk, 02 February 2015
In the wake of the Crisis, policymakers have introduced liquidity regulation to promote the resilience of banks and lower the social cost of crisis management. This column shows that a funding liquidity shock, manifested as lower access to wholesale sources of funding following a credit rating downgrade, translates into a significant decline in both domestic and foreign lending. Liquidity self-insurance by banks mitigates the impact of a credit rating downgrade on lending.
Yunus Aksoy, Henrique Basso, 29 January 2015
Banking activities have received increasing attention in the aftermath of the Crisis. This column focuses on the effects of bank portfolio choice on asset prices. The term spread is strongly influenced by banks’ expectations of their future profitability. Banks' funding activities, through the securitisation market, create conditions for higher leverage and may lead to a reduction in risk premia. Through its effects on asset prices, bank portfolio choice impacts the real economy, increasing its importance for policymaking.
Dirk Niepelt, 21 January 2015
Recent experience with the zero lower bound on nominal interest rates, and the use of high-denomination notes by criminals and tax evaders, have led to revived proposals to phase out cash. This column argues that abolishing cash may be neither necessary nor sufficient to overcome the zero lower bound problem, and would severely undermine privacy. Allowing the public to hold reserves at central banks could reduce the need for deposit insurance, although the transition to the new regime and the effects on credit supply must be carefully considered.
Xavier Vives, 22 December 2014
Banking has recently proven much more fragile than expected. This column argues that the Basel III regulatory response overlooks the interactions between different kinds of prudential policies, and the link between prudential policy and competition policy. Capital and liquidity requirements are partially substitutable, so an increase in one requirement should generally be accompanied by a decrease in the other. Increased competitive pressure calls for tighter solvency requirements, whereas increased disclosure requirements or the introduction of public signals may require tighter liquidity requirements.
Ron Alquist, Rahul Mukherjee, Linda Tesar, 22 December 2014
Foreign direct investment is an essential element in 21st century development strategies. This column discusses new evidence that estimates the importance of financial liquidity as a driver of such flows into emerging-market economies. Financial liquidity considerations are key determinants of the size and ownership structure of these investments.
Jean-Pierre Landau, 02 December 2014
Eurozone inflation has been persistently declining for almost a year, and constantly undershooting forecasts. Building on existing research, this column explores the conjecture that low inflation in the Eurozone results from an excess demand for safe assets. If true, this conjecture would have definite policy implications. Getting out of such a ‘safety trap’ would necessitate fiscal or non-conventional monetary policies tailored to temporarily take risk away from private balance sheets.
Olivier Blanchard, 03 October 2014
Before the 2008 crisis, the mainstream worldview among US macroeconomists was that economic fluctuations were regular and essentially self-correcting. In this column, IMF chief economist Olivier Blanchard explains how this benign view of fluctuations took hold in the profession, and what lessons have been learned since the crisis. He argues that macroeconomic policy should aim to keep the economy away from ‘dark corners’, where it can malfunction badly.
Marius Zoican, 20 September 2014
Technological advances in equity markets entered the spotlight following the Flash Crash of May 2010. This column analyses the advantages and disadvantages of algorithmic and high-frequency trading. Ever-faster exchanges do not always improve liquidity. Following a speed upgrade in the Nordic equity markets, effective spreads posted by high-frequency traders increased by 32%.
Alan Moreira, Alexi Savov, 16 September 2014
The prevailing view of shadow banking is that it is all about regulatory arbitrage – evading capital requirements and exploiting ‘too big to fail’. This column focuses instead on the tradeoff between economic growth and financial stability. Shadow banking transforms risky, illiquid assets into securities that are – in good times, at least – treated like money. This alleviates the shortage of safe assets, thereby stimulating growth. However, this process builds up fragility, and can exacerbate the depth of the bust when the liquidity of shadow banking securities evaporates.
Giovanni Cespa, Xavier Vives, 22 April 2014
Since capital flows to and from hedge funds are strongly related to past performance, an exogenous liquidity shock can trigger a vicious cycle of outflows and declining performance. Therefore, ‘noise’ trades – usually thought of as erratic – may in fact be persistent. Based on recent research, this column argues that there can be multiple equilibria with different levels of liquidity and informational efficiency, and that the high-information equilibrium can under certain conditions be unstable. The model provides a lens through which to interpret the ‘Quant Meltdown’ of August 2007 and the recent financial crisis.
Stefan W Schmitz, Heiko Hesse, 28 February 2014
Europe aims to implement Liquidity Coverage Ratio regulation by the end of 2014. This column discusses recent evidence on its impact. It finds that EU banks have not adjusted by reducing lending to the real economy, to SMEs, or to trade finance. Despite this adjustment, substantial liquidity risk exposure remains. Overall, the benefits of the LCR outweigh the costs by far.
Clemens Bonner, 06 February 2014
Liquidity risks can be a primary source of bank failures. As such, there are arguments not to rely on a single metric for providing supervision. This column describes research on detailed cases of failed and near-failed institutions, which helps highlight gaps in current practices of liquidity stress testing. It also gives guidance on how to design liquidity stress tests. Deposit insurance coverage, the heterogeneity of lending commitments, distinction between different types of repos, committed facilities, and derivative transactions should receive increased attention when designing liquidity stress tests.
Clemens Bonner, Iman van Lelyveld, Robert Zymek, 01 November 2013
What are the determinants of banks’ liquidity holdings and how are these reshaped by liquidity regulation? Based on a sample of 7,000 banks in 30 OECD countries, this column argues that banks’ liquidity buffers are determined by a combination of both bank- and country-specific variables. The presence of liquidity regulation substitutes for most of these determinants while complementing the role of size and institutions’ disclosure requirements. The complementary nature of disclosure and liquidity requirements provides a strong rationale for considering them jointly in the design of regulation.
Clemens Bonner, Sylvester Eijffinger, 14 October 2013
Liquidity requirements like the Basel III Liquidity Coverage Ratio are aimed at reducing banks’ reliance on short-term funding. This may have implications for the implementation of monetary policy, which usually operates through short-term interbank interest rates. This column looks at how banks reacted to the Dutch quantitative liquidity requirement. The authors conclude that liquidity requirements will only reduce overnight interest rates if they cause an aggregate liquidity shortage.