Description:
This study contributes to the understanding of liquidity in two ways. First, it considers the multifaceted nature of liquidity and its relationship with money. Second, it constructs a conceptual framework for a theory of liquidity. The first contribution is achieved by clarifying and categorising the various forms of liquidity to identify those overlooked by the existing literature. The second contribution consists of a realist critique of the literature on liquidity and money to highlight the strengths and weaknesses of each theoretical approach. The study reflects on the attempts to analyse liquidity using moneyless models of perfect barter with the assumption that every commodity exhibits perfect saleability; an assumption that removes any need for a medium of exchange and, moreover, crowds out all other forms of liquidity. It is concluded that, because liquidity is a social and monetary phenomenon, it cannot be analysed with models populated by a representative agent consuming a single commodity. Furthermore, this conclusion is not altered by the introduction of ‘financial frictions’, which are fundamentally at odds with the nature of money. Instead, the clarification of the nature of liquidity forms the basis for an interpretation of Keynes’s theory of liquidity preference that emphasises its reliance on liquidity in general, not money in particular. The study introduces the terms redemption liquidity and exchange liquidity to explain the trade-off that underpins the theory of liquidity preference. Properly interpreted, the theory of liquidity preference can then address many of the deficiencies prevalent in the dominant theories of the rate of interest. The study therefore has implications for monetary policy and asset pricing.
Description:
This study contributes to the understanding of liquidity in two ways. First, it considers the multifaceted nature of liquidity and its relationship with money. Second, it constructs a conceptual framework for a theory of liquidity. The first contribution is achieved by clarifying and categorising the various forms of liquidity to identify those overlooked by the existing literature. The second contribution consists of a realist critique of the literature on liquidity and money to highlight the strengths and weaknesses of each theoretical approach. The study reflects on the attempts to analyse liquidity using moneyless models of perfect barter with the assumption that every commodity exhibits perfect saleability; an assumption that removes any need for a medium of exchange and, moreover, crowds out all other forms of liquidity. It is concluded that, because liquidity is a social and monetary phenomenon, it cannot be analysed with models populated by a representative agent consuming a single commodity. Furthermore, this conclusion is not altered by the introduction of ‘financial frictions’, which are fundamentally at odds with the nature of money. Instead, the clarification of the nature of liquidity forms the basis for an interpretation of Keynes’s theory of liquidity preference that emphasises its reliance on liquidity in general, not money in particular. The study introduces the terms redemption liquidity and exchange liquidity to explain the trade-off that underpins the theory of liquidity preference. Properly interpreted, the theory of liquidity preference can then address many of the deficiencies prevalent in the dominant theories of the rate of interest. The study therefore has implications for monetary policy and asset pricing.