Effects of long term Liquidity Crisis in Economy

LiquidityMoney liquidity, in finance, referred as the total available amount of capital for spending and investments. And money liquidity effects in economy refers the changes in the accessibility of money supply and its following effects on investments, interest rates, consumptions and available price level. High money liquidity simply indicates that there is a huge availability of capital existed. In the other hand, the decreasing of money liquidity is known as liquidity crisis which may reveal a drop in asset prices less than their long run original price or fall in external funding conditions or even a decrease in the number of total market participants.

If countries face liquidity crisis for longer periods of times, at a time this can direct to solvency crisis since markets fear bond yields rise due to money liquidity. This ultimately causes elevated interest payments which make repaying of genuine debt considerably harder than before. The government is also forced indirectly into strict measures which direct to lower economic growth and make it difficult and complicated to attain growth rate positively as well as long term repay of dept. For that reason, entrée to market liquidity can aid but it can’t even solve an elementary condition of insolvency.

The forces mentioned above mutually strengthen each other during a liquidity crisis. The long term money liquidity affects the confidence of market participants who are in need of capital for business because they find it relatively hard to detect or find potential business partners to trade their resources. This may cause by a reduction in capital held by market participants and their limited financial market participation. As a result the investors are forced to sell their resources at a lesser price that are slighter than long term original price. Borrowers, on the other hand, usually face collateral requirements and higher loan costs, compared to times of abundant money liquidity along with unsecured debt. The mutual reinforcement of both funding liquidity and money market liquidity thus amplify the undersized depressing shock through several mechanisms to the economy that directs lack of money liquidity and ultimately causes a financial crisis.

Imagine what would happen if there occur a fall in customer confidence in bond markets due to long term money liquidity issues? The country might possess some genuine resources but the problem is still in the short term since it is incapable to achieve satisfactory financial help to meet her present expenditures. Therefore it makes clear sense about the importance of gaining control over market liquidity for country’s positive economic development.
Share this article :