Optimal Liquidity and Economic Stability

24 Pages Posted: 9 Aug 2012

See all articles by Linghui Han

Linghui Han

Tsinghua University

Il Houng Lee

International Monetary Fund (IMF)

Date Written: May 2012

Abstract

Monetary aggregates are now much less used as policy instruments as identifying the right measure has become difficult and interest rate transmission has worked well in an increasingly complex financial system. In this process, little attention was paid to the potential spillover of excess liquidity. This paper suggests a notional level of "optimal" liquidity beyond which asset prices will start to rise faster than the GDP deflator, thereby creating a gap between the face value and the real purchasing value of financial assets and widen the wedge in income between those with capital stock and those living on salaries. Such divergence will eventually lead to an abrupt and disorderly adjustment of the asset value, with repercussions on the real sector.

Keywords: Monetary Policy, Liquidity, Dynamic Panel, Monetary Aggregates

JEL Classification: C82, E22, E50

Suggested Citation

Han, Linghui and Lee, Il Houng, Optimal Liquidity and Economic Stability (May 2012). Available at SSRN: https://ssrn.com/abstract=2127029 or http://dx.doi.org/10.2139/ssrn.2127029

Linghui Han (Contact Author)

Tsinghua University

Il Houng Lee

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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