Create account Login Subscribe. The concept is critical for understanding the global financial cycle and international spillovers.
This column defines global liquidity as the ease of financing in cross-border markets and points to its potential drivers. To limit their exposures to global liquidity fluctuations nations can embrace better macro policy frameworks, consider capital flow management tools, and more stringently regulate and supervise banks.
The financial cycle is becoming increasingly global, as highlighted in recent work ReyBruno and ShinObstfeld and reflected market liquidity a primer of drug policy discussions e.
The phenomenon is evident from the correlation of credit growth across countries, which has increased markedly since the mids Figure 1.
This reflects, in part, deeper real economic integration through international trade red line in Figure 2and, in part, increased integration of countries into the global financial system, as illustrated by the expansion of cross-border banking claims before the financial crisis blue line in Figure 2.
And this number understates the role of G4 as financial centres, because international banks in G4 also intermediate much of cross-border credit between countries in the rest of the world.
Since G4 financial systems intermediate much of global credit, funding conditions — ease of credit — within G4 affect funding conditions globally. This is precisely what the concept of global liquidity aims to capture.
One can understand global liquidity as those credit supply factors in financial centre economies that affect the provision of cross-border credit. Under this definition, global liquidity is a specific case of funding liquidity ease of financing, see Brunnermeier and Pedersen It is different from asset market liquidity, that is, the ability to trade rapidly with small price impacts.
The fact that financial conditions and policies in G4 affect financial conditions globally has implications for the rest of the world. The key one is that the ability of recipient non-G4 countries to attract funds is determined not only by their domestic economic conditions and policies, but also by economic and financial conditions and policies within G4.
As such, knowing what specific conditions are relevant for the supply of funds becomes an important surveillance question for policymakers globally. And such knowledge can matter for formulating effective policy responses.
Against this background in recent paper Cerutti et al. We answer these questions by looking at a market liquidity a primer of drug type of cross-border flows: Other flows include bond flows, equity portfolio flows, FDI, etc. IMF studies the various types of cross-border flows and suggests that the results across different types of flows are similar.
The literature highlights a number of domestic G4 factors that may affect credit supply in cross-border funding markets:. We confirm, using US data, that all of these factors are important in driving cross-border credit:. In addition, global liquidity is driven by the relative price of foreign borrowing.
These price effects, however, are modest. An increase in the differential in interest rates between the recipient country and the US from its 25th to 75th percentile increases cross-border lending by only 0. Comparing these economic effects leads to an important observation. Global liquidity is determined by government actions and private sector conditions. Of course, this distinction is imprecise because government actions and private sector conditions affect market liquidity a primer of drug another.
Still, if one takes as a first order approximation that uncertainty and bank conditions reflect the private sector, while monetary policy and the interest rate differential reflect government actions, it appears that a predominant part of global liquidity is determined by the private sector rather than by direct government actions.
This challenges the view that monetary policy in advanced economies is largely responsible for the global financial cycle. Rather, evolving financial sector market liquidity a primer of drug, and often self-fulfilling market perceptions e. Many commentators presume that the global financial cycle is US-driven. We can check whether this is the case by looking at the relative power of conditions in the US versus other financial centres in explaining global liquidity.
Measures of uncertainty and risk-aversion are global in nature VIX measures are highly correlated across countriesbut bank conditions and monetary policy indicators have sufficient heterogeneity across G4. To abstract from regional effects e. This highlights that while the US drives the global financial cycle through its monetary policy, other financial centres — the UK and the Eurozone — affect the global financial cycle through the conditions of their banks, consistent with their major global financial intermediation role Shin Borrowing countries may want to limit their market liquidity a primer of drug to global liquidity fluctuations to better control domestic financial conditions.
This column summarized market liquidity a primer of drug stylized facts about global liquidity, building on existing literature and new results. The fact that global liquidity is in large part driven by G4 conditions has both positive and negative implications for the rest of the world.
Since access to foreign capital is good for economic market liquidity a primer of drug, accommodative conditions in G4 that boost cross-border flows can increase economic development and growth elsewhere.
Arguably, this has been one of the beneficial effects of current accommodative monetary policies in G4. But there is also scope for risks when too accommodative conditions in G4 contribute to credit booms elsewhere, or when a tightening in G4 triggers sudden stops in capital flows or even outflows from the rest of the world that test limits of macroeconomic policy management.
Balancing these effects, particularly in the context of a shifting, unconventional monetary policy cycle in advanced economies, will be challenging. Overall, our understanding of forces driving the global financial cycle is still in its infancy.
For example, China may also be considered as a 'financial centre' economy, which market liquidity a primer of drug the rest of the world. But the analysis of China's role in global liquidity is restricted by data availability.
International finance Macroeconomic policy. Systemic risks in global banking: What available data can tell us and what more data are needed?
Economic rationale and optimal tools. Giovanni Favara, Lev Ratnovski. Why is global liquidity important? What drives global liquidity, i.
Where does the global financial cycle originate? Is it primarily US-driven, or do other financial centre economies play a role? How can a borrowing country manage its exposure to global liquidity fluctuations? What drives global liquidity? The literature highlights a number of domestic G4 factors that may affect credit supply in cross-border funding markets: Uncertainty and risk aversion, typically captured by VIX Rey ; Domestic credit conditions, captured as bank leverage high for more accommodative conditions, see Bruno and Shindomestic credit growth Borio and Loweor TED spread.
We market liquidity a primer of drug, using US data, that all of these factors are important in driving cross-border credit: An increase in the term premium from its 25th to 75th percentile decreases cross-border lending to banks and real sector by 1. Which countries drive global liquidity? For monetary policy, US factors play an overwhelming role. UK and Eurozone term premium, interest rates, and money growth are mostly not significant.
Can countries manage their exposures to global liquidity? A better macro framework, such as a flexible exchange rate. The difference is smaller for cross-border flows to the real sector: Stricter capital controls also reduce cross-border inflows to banks from about Concluding thoughts This column summarized key stylized facts about global liquidity, building on existing literature and new market liquidity a primer of drug.
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