The Role of Insurance in Ensuring Financial Market Liquidity

In the last 20 years, economists and financial analysts have reacted to Keynesian and post-Keynesian analyses by turning away from macro-economics or by focusing more narrowly on inflation and structural factors, rather than on liquidity. At the same time, they have not really called into question the basic assumptions of the Keynesian paradigm, according to which the central bank controls economic liquidity by controlling money supply.Recent financial crises have quite understandably shaken their convictions. First of all, the crisis that rocked the economies of South-East Asia underscored the importance of liquidity in driving market efficiency, and the pivotal role that financial institutions could play quite independently of the central banks. Secondly, the Japanese crisis has called attention to the special role played by the insurance industry in ensuring economic liquidity, a role that is often insufficiently understood. Of particular significance is the fact that, although the insurance industry cannot play a counter-cyclical role with respect to global demand, it can nonetheless play just this role with respect to financing the economy.This article explores and develops the role of insurance in supplying liquidity. After defining a few useful terms, we will turn to the role played by insurance in supplying macro-economic liquidity. We will then attempt to gain a better understanding of how insurance contributes to micro-economic liquidity, a subject of analysis that we believe is both fruitful and largely underexploited. The Geneva Papers on Risk and Insurance (2001) 26, 346–359. doi:10.1111/1468-0440.00120