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Illiquidity and All Its Friends

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  • Tirole, Jean

Abstract

The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistics, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity and analyses how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyses optimal combinations thereof; it stresses the need for macroprudential policies.

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Bibliographic Info

Paper provided by University of Toulouse 1 Capitole in its series Open Access publications from University of Toulouse 1 Capitole with number http://neeo.univ-tlse1.fr/2316/.

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Date of creation: Jun 2011
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Publication status: Published in Journal of Economic Literature (2011-06) v.49, p.287-325
Handle: RePEc:ner:toulou:http://neeo.univ-tlse1.fr/2316/

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Web page: http://www.univ-tlse1.fr/

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Cited by:
  1. Chudik, Alexander & Fratzscher, Marcel, 2011. "Identifying the global transmission of the 2007-2009 financial crisis in a GVAR model," European Economic Review, Elsevier, vol. 55(3), pages 325-339, April.
  2. Radde, Sören, 2012. "Liquidity Crises, Banking, and the Great Recession," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 65408, Verein für Socialpolitik / German Economic Association.
  3. Andreas Fuster & James Vickery, 2013. "Securitization and the fixed-rate mortgage," Staff Reports 594, Federal Reserve Bank of New York.
  4. Alexander Chudik & Marcel Fratzscher, 2011. "Identifying the global transmission of the 2007-09 financial crisis in a GVAR Model," Working Paper Series 1285, European Central Bank.
  5. Sören Radde, 2012. "Flight-to-Liquidity and the Great Recession," Discussion Papers of DIW Berlin 1242, DIW Berlin, German Institute for Economic Research.
  6. Diana Bonfim & Moshe Kim, 2012. "Liquidity risk in banking: is there herding?," Working Papers w201218, Banco de Portugal, Economics and Research Department.
  7. Rudiger Ahrend & Antoine Goujard, 2012. "International Capital Mobility and Financial Fragility - Part 3. How Do Structural Policies Affect Financial Crisis Risk?: Evidence from Past Crises Across OECD and Emerging Economies," OECD Economics Department Working Papers 966, OECD Publishing.
  8. Christophe Van Nieuwenhuyze, 2013. "Debt, assets and imbalances in the euro area. An aggregate view," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(1), pages 123-152.
  9. Alexander Chudik & Marcel Fratzscher, 2012. "Liquidity, risk and the global transmission of the 2007–08 financial crisis and the 2010–11 sovereign debt crisis title," Globalization and Monetary Policy Institute Working Paper 107, Federal Reserve Bank of Dallas.
  10. Iman van Lelyveld & Daan in 't Veld, 2012. "Finding the core: Network structure in interbank markets," DNB Working Papers 348, Netherlands Central Bank, Research Department.
  11. Alexander Chudik & Marcel Fratzscher, 2012. "Liquidity, risk and the global transmission of the 2007-08 financial crisis and the 2010-2011 sovereign debt crisis," Working Paper Series 1416, European Central Bank.
  12. Claudio Borio, 2011. "Rediscovering the macroeconomic roots of financial stability policy: journey, challenges and a way forward," BIS Working Papers 354, Bank for International Settlements.
  13. Dell'Anno, Roberto & Dollery, Brian, 2012. "Comparative fiscal illusion: A fiscal illusion index for the European Union," MPRA Paper 42537, University Library of Munich, Germany.

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