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The dynamic impact of monetary policy on stock market liquidity

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  • Lyu, Xiaoyi
  • Hu, Hao

Abstract

Stock market liquidity is a crucial precondition for well-functioning financial markets, while monetary policy is an important determinant for Stock market liquidity. This paper examines the dynamic impact of monetary policy on stock market liquidity in the short, medium, and long run and the asymmetry of the impact in bull and bear markets. Time-varying parameter vector autoregressive model is applied to study the monetary policy and stock market liquidity of China over the period 1997–2018. The results show that the impact of monetary policy on stock market liquidity varies across time and markets. Expanding monetary policy can help replenish stock market liquidity only if stable liquidity expectations are established. Therefore, when the central bank intends to influence stock market liquidity by regulating funding liquidity, it first needs to strengthen the management of liquidity expectations to establish funding liquidity expectations and prevent the market from falling into a liquidity spiral.

Suggested Citation

  • Lyu, Xiaoyi & Hu, Hao, 2024. "The dynamic impact of monetary policy on stock market liquidity," Economic Analysis and Policy, Elsevier, vol. 81(C), pages 388-405.
    • Handle: RePEc:eee:ecanpo:v:81:y:2024:i:c:p:388-405
    DOI: 10.1016/j.eap.2023.12.007
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    Keywords

    Market liquidity; Funding liquidity; Monetary policy; Liquidity spirals;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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