Research On Liquidity Shocks And Financial Stability

Since the 1980's, with the development of financial globalization and liberalization, the risks faced by the international financial sector have continued to increase, the stability of the financial system has been threatened not only by his country's economic operation but also by the country's economic fluctuation, the financial crisis outbreak one after another. Summing up the history of financial crises, we can find that the volatility of liquidity has been an important element which will threat the financial stability. This paper uses a series of economic and financial principles and scientific research methods to analyze the particularity and complexity of the mechanism of how liquidity shocks affect the financial stability, therefore this paper bears not only urgent practical meanings, but also certain theoretical value.In the current relevant literatures about the liquidity shocks and financial stability, there are more comprehensive studies concerning the excess liquidity of the macro-analysis. However, the researches on the crunch of liquidity are not so much. Especially, the researches from the micro aspect are very few. From the micro aspect, the liquidity shocks affect the financial stability immediately through two channels:the balance sheet and asset prices. By means of analysis about 2008-2009 US financial crisis, we find that the shocks of the liquidity will lead to asset price declines and further monetary tightening through the role of liquidity spirals. Analysis on the conversion from the excess liquidity to the crunch liquidity and the mechanism of how liquidity shocks affect the financial stability helps to strengthen our knowledge and research on the liquidity and financial stability issues. At the same time, Liquidity shocks can also affect the financial market stability through the channel of asset price effects indirectly. Liquidity shocks will lead to asset price volatility. And asset price volatility will induce the instability in the financial system through a variety of channels. Therefore, we should study the mechanism of how the liquidity shocks affect the financial stability through the asset price channel not only from the micro aspect but also from the macro aspect. In short, these indepth studies will help central banks and the Chinese financial authorities and other countries to take timely and effective monetary policy and fiscal policy to deal with the increasingly complicated economic situation, to maintain the long-term financial stability, and to maintain the healthy and sustainable development of world economy.Against the US financial crisis background, This paper takes the mechanism of how liquidity shocks affect the financial stability as the research object, and discusses how to manage the liquidity shocks and its subsequent asset price bubble, as well as the problems of financial stability because of dramatic rising and falling of asset price. It also proposed some simple and effective policy recommendations about how to deal with the liquidity shocks and to maintain financial stability in China. This paper is composed of four parts. First of all, by studying on the literatures of China and other countries, this paper gives a literature review on recent researches and clarifies the concept and the extension of the liquidity and financial stability. Furthermore, it analyzes the factors which will affect liquidity risk and financial stability. On the basis of the above analysis, it presents a logical framework of this paper in the first part, which includes chapter 2 and 3.We should study the issues about the liquidity and financial stability From both the micro and macro aspects, and through two channels of the balance sheet and asset prices. In the second part which includes chapter 4, this paper systemically analyzed the mechanism of how liquidity shocks affect the financial stability through the micro channel of the balance sheet by theoretical and empirical analysis. Moreover, it also studies the variations of the liquidity spirals in the financial markets of China with local datas during the financial crisis. Hereafter, in the third part which includes chapter 5, this paper studies the mechanism of how liquidity shocks affect the financial stability through the macro channal of the asset price volatility by theoretical and empirical analysis. Finally, this paper proposed that China's central bank and the relevant departments should strengthen and improve the financial supervision from the macro and micro aspects. and it also proposed some simple and effective policies and recommendations about how to deal with the liquidity shocks and to maintain financial stability in China.