When the rivers run dry

"Can bank regulators and central banks prevent future liquidity crises?POLICYMAKERS and academics are still grappling with the causes and consequences of the credit crunch. One broad area of agreement is that ample ?liquidity? encouraged the lax lending that led to bad mortgage debts, and a sudden dearth of it helped to precipitate the crisis. But what is liquidity, why does it suddenly evaporate and what can central banks and regulators do to ensure that its ebb and flow does not destabilise economies? This and much else is the subject of a special issue of the Bank of France's Financial Stability Review.* The essence of liquidity is the ability to raise ready money to meet pressing spending needs. A firm is liquid if it has enough cash to pay its suppliers and employees and finance its investment. This funding liquidity is linked to a second facet, market liquidity?the ease with which assets can be sold without losing their value. If financial markets were complete and perfectly liquid, firms and households could always raise cash by pledging their future earnings in return. Both funding and market liquidity rely on a big enough pool of monetary liquidity to draw upon. This is a third aspect of liquidity: the amount of central-bank money flowing around the economy. ..." (2008-3-6)

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