Liquidity shortages: theoretical underpinnings.

Abstract

Liquidity shortages arise when financial institutions and industrial companies scramble for, and cannot find the cash they require to meet their most urgent needs or undertake their most valuable projects. Liquidity problems are compounded when some actors do have excess liquidity, but are unwilling to lend it at the maturities desired by prospective borrowers. The paper revisits the theoretical underpinnings of such liquidity shortages: what drives corporate liquidity demand and supply? How is the latter affected by financial innovation? When does the economy produce enough liquidity for its own needs, and what is the role of public policy? The paper also offers some comments on the recent subprime episode and its implications for prudential regulation, rating agencies and public policy