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A Study of Liquidity Conduction Mechanism

Author: HanXue
Tutor: WangXiaoFeng
School: Dongbei University of Finance
Course: Finance
Keywords: Monetary liquidity Financial institutions’ liquidity Banks’liquidity Market’s liquidity Liquidity conduction mechanism
CLC: F832
Type: Master's thesis
Year: 2012
Downloads: 52
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Abstract

Due to the impact of the domestic and external economic situation, the liquidity condition of our country have fluctuated more severely in recent years. This produces many adverse effects on our economy and people’s living standard. In order to control the price growth, the central bank began to use of monetary policy operations to adjust liquidity frequently. However, it’s not very effective.There are many reasons for failure of monetary policy, and this paper explains this problem from the conduction mechanism of liquidity fluctuations. After a long period of development," liquidity " is no longer limited to the monetary field. Right now, it has become a wide outer edge, multi-level concept. Using certain mechanisms, the fluctuation of one liquidity level can be conducted through different levels. This makes the effect of monetary policy deviate from the expected target. Therefore, when using monetary policy to adjust liquidity, the central bank should consider the impact of liquidity’s conduction process.Liquidity can be divided into macro, meso and micro levels. In general, macro liquidity refers to monetary liquidity and micro liquidity refers to market liquidity, but there is some controversy about the concept of meso liquidity. Past studies generally use the bank’s liquidity as representatives of the concept of meso liquidity, which is because the commercial banks occupy a leading position in the financial system. However, with the continuous development of the economy and the improvement of the financial system, the non-bank financial institutions also began to play a very important role in the economy, so this paper consider that the meso level should contain the liquidity of all financial institutions. This paper analyzes the conduction mechanism of different liquidity levels by VAR model, and compares the role which the financial institutions’liquidity and the banks’liquidity play in the conduction process. The result is as follow:The financial institutions’liquidity and the banks’liquidity have a different impact on market liquidity; The "macro liquidity→meso liquidity→micro liquidity "conduction mechanism, which is like "top-down", exists in the short term, but does not exist in the long term; The"macro liquidity→meso liquidity→micro liquidity " conduction mechanism, which is like "bottom-up", always exists; Both of the two conduction mechanisms existing at the same time will amplify the effects of monetary policy. Therefore, in order to improve the effectiveness of the liquidity conduction mechanism, China should focus on the development of non-bank financial institutions, while ensure banks playing a fundamental role in the financial sector. When conducting monetary policy adjustment, the central bank should follow the principle of prudence, to avoid liquidity conduction cycle’s amplifying effect making the effect of monetary policy exceed the expected goal.The specific structure of this article is as follows:The first part is an introduction. This chapter first describes the background and significance of this article’s topic, then explains the methods and ideas of the research. Finally it points out that the innovation and inadequacies of this paper.The second part is the domestic and international literature review. This chapter describes the relevant reference of this paper from three angles, which is flow classification, a measure of liquidity and liquidity conduction mechanism. And then summarizes the results of these studies.The third part is the theoretical foundation. This chapter firstly elaborates the concept and connotation of liquidity, and then describes the different academic divisions of the liquidity, giving this classification this paper uses and the reasons for using it. Finally this chapter analyzes the theoretical conduction mechanism of liquidity.The fourth part is the empirical research. This chapter firstly declares the indicators of different liquidity levels, and uses unit root test and cointegration test to examine the stationarity of the data and the relationship between the variables. Secondly we uses Granger causality test to analyze the causal relationship between the changes of different liquidity levels. Finally, we investigates the specific form of the liquidity conduction mechanism of our country through the VAR model impulse response method, and analyzes the different roles played by the liquidity of financial institutions and bank liquidity in the liquidity conduction process through a comparison.The fifth part is the empirical results analysis and policy recommendations. This chapter firstly analyzes the meaning represented by the empirical results, considering the actual situation of our liquidity management. And secondly explains the impact of liquidity conduction mechanism on the effects of monetary policy. Finally, we put forward some recommendations on the monetary policy of the central bank in the liquidity management strategy, according to the analysis of the empirical results.The sixth part is the conclusion. This chapter summarizes the writing process of this paper, and points out the research space of this problem in the future.

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