Liquidity monetary policy and financial cycles, Inglese

LIQUIDITY, MONETARY POLICY AND FINANCIAL CYCLES

A close look at how financial intermediaries manage their balance sheets

suggest that these institutions raise their leverage during assets price

booms and lower it during down turns.

The authors of this study argue that the growth rate of aggregate balance

sheets in the most fitting measure of liquidity in a market – based

financial system.

Moreover, the authors show a strong correlation between balance sheet

growth and monetary policy.

So, institutions increase their leverage during booms and reduce it during

down turns.

So financial institutions leverage is “pro-cyclical”; the expansion and

contraction of balance sheets amplifies, rather then counteracts, the

credit cycle.

In line with the focus on balance sheets management, is presented a new

definition of liquidity as the growth rate of financial intermediaries’

balance sheets.

When monetary policy is “loose”, financial institutions expand their

balance sheets and the supply of liquidity increases. Conversely, when

monetary policy is “tight” , institutions shrink their balance sheets,

reducing the overall supply of liquidity.

Consequences of Pro-Cyclical Leverage:

Pro-cyclical leverage offers a window on the notion of financial system

liquidity. Pro-cyclical leverage reverses the normal demand and supply

responses to asset price changes.