Collateral restrictions and liquidity under-supply: a simple model (Q926227)

The paper deals with the concept of liquidity interpreted as a flexibility to move goods and money across different investments. Its main goal is to explain liquidity supply from the point of view of an equilibrium between the firms' choice of their liquidity positions and the liquidity of the whole economy. A simple model of the liquidity concept, its under-supply, and of the equilibrium concept related to them are explained and analyzed. It is shown that a sufficient condition for getting liquidity under-supply is the presence of credit constraints on demands, and that the aggregate under-supply of liquidity need not a characteristic of emerging market economies. Moreover, the relation between the liquidity under-supply and the demand distortion initiating it is discussed.