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.
JEL codes
- E44: Financial Markets and the Macroeconomy
- E52: Monetary Policy
- G28: Government Policy and Regulation
Replaced by
Jean Tirole, “Illiquidity and All Its Friends”, Journal of Economic Literature, vol. 49, n. 2, June 2011, pp. 287–325.
Reference
Jean Tirole, “Illiquidity and All Its Friends”, TSE Working Paper, n. 09-083, September 12, 2009, revised February 2010, 42 pages.
See also
Published in
TSE Working Paper, n. 09-083, September 12, 2009, revised February 2010, 42 pages