Internal And External Imbalances Of The Supply Of Liquidity, Asset Prices And Monetary Policy Choice

In the 1930's the market economic countries, which advocate"invisible hands"encountered with a severe economic crisis. When recovered from this recession, the Keynesianism, which emphasizes on government interventions, has become the mainstream after rethink profoundly on government's function upon the market economics. Meanwhile, economists were assuming, could the crisis be avoided if the government had applied some monetary policy before the crisis, or could the damage be reduced and recovery speeded up if the government had taken some more immediate action after the collapse down.If the major concern of the Great Depression was lack of"liquidity or short in demand", the financial crisis in Japanese and South-east Asia occurred in the 1990s'was a result of"excessive liquidity". Also, the United States which suffers from the financial crisis is also a victim of continuous expansion and final burst of asset bubbles due to the liquidity excess.When we analyze the above financial turbulence, we can easily find out the background of the crisis is always the economic imbalance during the economic globalization. The thread of the financial turbulence is always the"liquidity"and"asset bubbles". Therefore, the author is trying to discover the relationship among economic imbalance, liquidity and asset price as well as which kind of Monetary Policy the central bank takes is more helpful to prevent the crisis and promote recovery from the economic crisis.Insufficient consuming and excessive saving has become the internal factor for China's economic imbalance, so as the irrational international industry separation system as the external factor. This internal and external imbalance will affect the financial security of China's economic system.How to deal with the liquidity has become the main thread of this essay. First of all, the essay defines liquidity and excess liquidity, conclude that the excess liquidity is hard to quantify neither in theory nor in practice. The reason is that: Since no one can predict the exact risk and return of assets in long-term under the natural sense of greed and dread, the central banks are also hard to make quick decisions. When finally the excess liquidity is determined by the central bank, long-term investment may have been overheated and formed a lot of asset bubbles. It would be too late for central banks to make decisions whether to eliminate the bubbles. After all, what can be done for the central banks to stabilize the finance market? The author believe that central bank should focus themselves more on their own liquidity supply, focus on the relationship between asset term adjustment, finance stability and liquidity supply. Whenever abnormal long and short term asset turnover shows up, central banks should make take good control over various monetary tools like interest rate, currency supply to influence the public expectation in order to restrain excessive speculation and avoid financial turbulence. From the above mentioned, it can be conclude that: The central bank should not take action until the excess liquidity is judged, but modify the liquidity supply from time to time, in order to warn and lead the public expectation and thus avoid the form of asset bubbles.By using the vector auto regression model(VAR), the essay analyzes the following 6 variables and identifies their correlation Granger cause relation. M1 and total loans of financial institutions, which stands for the liquidity; CPI and PPI, which stands for inflation; Shanghai Security Index (SHI), which stands for asset prices; China housing Index (ZEI)The Unit root test of stationarity shows that every variable is first-order cointegration I(1), it becomes stationary after difference process. There exists a stationery cointegration relationship between each variable. While the Granger cause relation analysis shows that the China housing Index (ZEI) has two way Granger cause relationship with total loans of financial institutions and M1; the Shanghai Security Index (SHI) also has two way Granger cause relationship M1. This result shows that the monetary supply and total loan amount has great correlation with asset prices such as stock price and housing price. The M1 and housing index are leading the CPI, which means the raise of asset prices will stimulate consuming and at last cause the deepening of inflation.The Econometric method shows that, there is a complex one-way or two-way relationship among variables of monetary supply, total loan amount, asset price and inflation. Thus, author believes it is impossible to avoid"excessive liquidity"and"liquidity black holes"as well as maintain asset price stable by controlling a single monetary policy intermediate goal. Up to now, we can yet judge an appropriate level of asset bubbles, not to say controlling of them. Therefore, by taking into considerate a number of monetary policy intermediate goals and control accordingly has become the rational choice of China's Central Bank. When economy is moving towards recession, the central bank should provide adequate liquidity, while the economy is heated or stable, the central bank should tighten the monetary supply by controlling loan amount as well as using the interest rate leverage. The Econometric method shows the M1 and total loan amount are highly related with asset bubbles, while the excessive monetary supply and financial support will lead to excessive liquidity and thus cause asset bubbles. Therefore, it is of great significance to control monetary supply and keep an eye on loan amount of financial institutions. Since the real effect of monetary policy is to guide or warn the market, thus the credibility and efficiency has currently become what central bank need to maintain most.