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Private and Public Supply of Liquidity

01 Nov 1996-Research Papers in Economics (Massachusetts Institute of Technology (MIT), Department of Economics)-
TL;DR: In this article, the authors address a basic, yet unresolved question: Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the State have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means?
Abstract: This paper addresses a basic, yet unresolved question : Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the State have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means?
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TL;DR: In this article, the authors provide a model that links an asset's market liquidity and traders' funding liquidity, i.e., the ease with which they can obtain funding, to explain the empirically documented features that market liquidity can suddenly dry up, has commonality across securities, is related to volatility, is subject to flight to quality, and comoves with the market.
Abstract: We provide a model that links an asset's market liquidity - i.e., the ease with which it is traded - and traders' funding liquidity - i.e., the ease with which they can obtain funding. Traders provide market liquidity, and their ability to do so depends on their availability of funding. Conversely, traders' funding, i.e., their capital and the margins they are charged, depend on the assets' market liquidity. We show that, under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals. The model explains the empirically documented features that market liquidity (i) can suddenly dry up, (ii) has commonality across securities, (iii) is related to volatility, (iv) is subject to “flight to quality¶, and (v) comoves with the market, and it provides new testable predictions. Keywords: Liquidity Risk Management, Liquidity, Liquidation, Systemic Risk, Leverage, Margins, Haircuts, Value-at-Risk, Counterparty Credit Risk

3,638 citations

Journal ArticleDOI
TL;DR: The authors summarizes and explains the main events of the liquidity and credit crunch in 2007-08, starting with the trends leading up to the crisis and explaining how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.
Abstract: This paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.

3,033 citations

Journal ArticleDOI
TL;DR: The authors developed a quantitative monetary DSGE model with financial intermediaries that face endogenously determined balance sheet constraints and used the model to evaluate the effects of the central bank using unconventional monetary policy to combat a simulated financial crisis.

2,158 citations

Book ChapterDOI
TL;DR: The authors developed a canonical framework to think about credit market frictions and aggregate economic activity in the context of the current crisis, and used the framework to address two issues in particular: first, how disruptions in financial intermediation can induce a crisis that affects real activity; and second, how various credit market interventions by the central bank and the Treasury of the type we have seen recently, might work to mitigate the crisis.
Abstract: We develop a canonical framework to think about credit market frictions and aggregate economic activity in the context of the current crisis. We use the framework to address two issues in particular: first, how disruptions in financial intermediation can induce a crisis that affects real activity; and second, how various credit market interventions by the central bank and the Treasury of the type we have seen recently, might work to mitigate the crisis. We make use of earlier literature to develop our framework and characterize how very recent literature is incorporating insights from the crisis.

1,900 citations

Journal ArticleDOI
TL;DR: The authors survey 1,050 CFOs in the US, Europe, and Asia to assess whether their firms are credit constrained during the global financial crisis of 2008 and find that constrained firms planned deeper cuts in tech spending, employment, and capital spending.
Abstract: We survey 1,050 CFOs in the US, Europe, and Asia to directly assess whether their firms are credit constrained during the global financial crisis of 2008 We study whether corporate spending plans differ conditional on this survey-based measure of financial constraint Our evidence indicates that constrained firms planned deeper cuts in tech spending, employment, and capital spending Constrained firms also burned through more cash, drew more heavily on lines of credit for fear banks would restrict access in the future, and sold more assets to fund their operations We also find that the inability to borrow externally caused many firms to bypass attractive investment opportunities, with 86% of constrained US CFOs saying their investment in attractive projects was restricted during the credit crisis of 2008 More than half of the respondents said they canceled or postponed their planned investments Our results also hold in Europe and Asia, and in many cases are stronger in those economies Our analysis adds to the portfolio of approaches and knowledge about the impact of credit constraints on real firm behavior

1,467 citations