liquidity

Examples of liquidity in the following topics:

• Measuring the Money Supply: M2

  • M2 is a broader measure of the money supply than M1, including all M1 monies and those that could be quickly converted to liquid forms.
  • Narrow measures include only the most liquid assets, the ones most easily used to spend (for example, currency and checkable deposits).
  • Broader measures add less liquid types of assets (certificates of deposit, etc.).
  • M2 consists of all the liquid components of M1 plus near-monies.
  • Near monies are relatively liquid financial assets that may be readily converted into M1 money.

• Limitations of Monetary Policy

  • Limitations of monetary policy include liquidity traps, deflation, and being canceled out by other factors.
  • In a liquidity trap, bonds pay little to no interest, which makes them nearly equivalent to cash.
  • Thus, if an economy enters a liquidity trap, further increases in the money stock will fail to further lower interest rates and, therefore, fail to stimulate.
  • A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.
  • This is a liquidity trap.

• The Demand for Money

  • This is the equivalent of stating that the nominal amount of money demanded (Md) equals the price level (P) times the liquidity preference function L(R,Y)--the amount of money held in easily convertible sources (cash, bank demand deposits).
  • Specific to the liquidity function, L(R,Y), R is the nominal interest rate and Y is the real output.
  • However inherent to the holding of money is the trade-off between the liquidity advantage of holding money and the interest advantage of holding other assets.

• Measuring the Money Supply: M1

  • M1 captures the most liquid components of the money supply, including currency held by the public and checkable deposits in banks.
  • M3 encompassed M2 plus relatively less liquid near monies.

• The Slope of the Aggregate Demand Curve

  • There are only two times when the Keynes observation on the interest rate effect will be inaccurate, and that is if the IS (investment savings) curve were to be vertical or if the LM (liquidity preference money supply) curve were to be horizontal.
  • This makes sense if you think about it, it would basically equate to a liquidity trap.
  • In the context of the above discussion on Keynes, Pigou's Wealth Effect underlines the fact that liquidity traps are not sustainable.
  • The IS-LM model takes investments and savings and compares that to liquidity and the overall money supply.

• The Effect of Expansionary Monetary Policy

  • The discount window allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions.
  • All banks are required to have a certain amount of cash on hand to cover withdrawals and other liquidity demands.

• The Effect of Restrictive Monetary Policy

  • The discount window allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions
  • All banks are required to have a certain amount of cash on hand to cover withdrawals and other liquidity demands.

• Consequences of Banking Crises

  • When banks lack liquidity to invest, businesses that depend upon loans struggle to raise the capital required to execute upon their operations.
  • The fall in liquidity and investment drives up unemployment, drives down governmental tax revenues and reduces investor and consumer confidence (damaging equity markets, which in turn limits businesses access to capital).

• Shifts in the Money Demand Curve

  • The demand for money is a result of the trade-off between the liquidity advantage of holding money and the interest advantage of holding other assets.
  • The level of nominal output has increased and there is a liquidity advantage in holding on to money.

• The Federal Reserve and the Financial Crisis of 2008

  • The Federal Reserve's response to the 2008 crisis saw the use of both conventional and new monetary tools in order to stabilize the economy, support market liquidity, and encourage economic activity.
  • Further, this type of financial crisis meant that banks' assets were suddenly worth far less; open market operations can ensure that these banks have the liquidity they need to carry out their financial activities.
  • These new credit facilities were created based on the hope that increasing liquidity in the market would induce firms and consumers to borrow and spend.