Excess Liquidity, Inflation And Asset Price

In recent years, the monetary conditions of major economies all around the world have a significant character, whose macro liquidities were obvious excessive during 2001 to 2007, but this trend reversed sharply to extreme shortage of liquidity because the real economy gradually stuck in the recession after the explosively outburst of sub-prime mortgage financial crisis in the second half year of 2007. Facing the worsening economy prospect triggered by the financial crisis, many countries around the world adopted positive monetary and fisical policies, which caused the reversal from liquidity shortage to excess liquidity. Meanwhile, the excess liquidity and its sharp downturn to shortage was widely considered as the principal reason of magnified volatility of inflation and asset price. What is the effect and mechanism of the condition of macro liquidity, excess or shortage, on inflation and asset prices, and to what extent was the effect? What was the origin of the excess liquidity, or liquidity shortage? Did it rooted in the monetary authorities' mis-ajustment because of the unstable monetary supply and demand functions, or the spill-over of the external monetary liquidity condition, or the endogenous liquidity creation mechanism which origins from the dynamic adjustment behaviors based on sectoral balance sheets by the economic sectors? What was the function played by the boom and bust of asset prices and inflation expectation during the downturn of liquidity from excess to shortage? Were the monetary policy and fiscal policy adopted effectively, given the different kinds of excess liquidity origins? All above questions are both theoretical and realistic problems of great value, especially facing the complicated international financial crisis and turbulence and recession of major economies nowadays.Firstly, we take a glance of the monetary liquidity conditions of ten countries or economies during 1999 to 2008, and have a preparatory analysis of the relation between liquidity, inflation and asset prices. Based on the measure of "Marshall K", we define and measure the liquidity and the extent of excess liquidity or liquidity shortage. Using the historical data, we conduct empirical analysis of the statistical effect of excess liquidity on inflation and asset prices, which samples globally, including ten major countries and the economy groups of emerging countries BRIC and developed countries G6. Based on the discrete choice model Probit, we analyze the probability of the event: excess liquidity triggers inflation and asset price boom, which is taken for granted in common sense. Upon the conclusion, we find that, in despite of inconspicuous statistical evidence, sustained excess liquidity, real economic growth, demonstration effect of risky asset prices boom, real interest rate keeping low level, numbers of countries having excess liquidity simultaneously and period of excess liquidity lasting, all significantly make a positive contribution to the probability of the hypothetical event. At the same time, we find the changed trend of excess liquidity leading role, from developed countries to emerging countries, and obviously this had a significant effect on inflation. Due to the lack of recent data, we cannot find the evidence that sub-prime mortgage financial crisis have an actual effect.Focused on the significant characters shown by Chinese monetary excess liquidity during 2005 to 2008, we model the monetary demand and supply functions separately, and include the asset prices and inflation endogenously in a simultaneous equations framework with goods, money and credit markets involved. From the point of view that excess liquidity or liquidity shortage origins from the non-equilibrium of monetary demand and supply, which could give us a clearer deep insight of the change of monetary liquidity conditions. Within this analytical framework, we review the effect on excess liquidity of various exogenous variables, such as external shock, policy basket adopted by monetary authorities and voluntary behaviors adopted by commercial banks. Furthermore, we carefully scrutinize the role played by inflation and asset prices during the change of liquidity conditions. On the aspect of money supply, we explore the important part of external excess liquidity spillover, hot money, which is aimed at speculation on exchange rate, interest rate and asset prices in china. We also consider the hedging effect of the policy basket adopted by central bank and the role played by the excess reserve ratio adjustment behavior of commercial banks. On the aspect of money demand, we divide the macro economy into real economy and artificial economy according to their different characters, and explore the effect of different trends of money circulation velocity of these two monetary systems have on the monetary demand. We also take into account of the effects of asset prices on artificial economy, and commodity price on inflation expectation.As found by the empirical study' s conclusions of both sides of money supply and demand, the growth rate of endogenous money demand were lower than the growth rate of money supply before the first half year of 2008. But after then, with the outburst of financial crisis and economic recession, the external excess liquidity spillover reversed, including the downturn growth rate of Chinese trade surplus because of lower external demand, reversion of RMB exchange rate appreciation expectations, and hedging policy of central bank and excess reserve ratio adjustment behavior of commercial banks became of restriction. These all decrease the pressure on money supply; even make the money supply lower than the endogenous money demand. On the other side of money demand aspect, with the asset prices collapse and bigger volatility, including commodities prices, after the second half year of 2008, the monetary circulation velocity of artificial economy rised significantly, meanwhile, the velocity of real economy seemed stable. At the same time, the ratio of money which flowed into the real economy rised accordingly, and the growth rate of money demand of the whole economy decreased slightly. Synthesized from these two sides, we found that the condition of Chinese excess liquidity had an obvious reversal after the second half year of 2008.The last part of analysis goes into the deeper view of sectoral economy; we relate the change of monetary liquidity conditions with the sectors' assets/liabilities adjustment behaviors. We take this research angle because the micro-foundation of sectoral change of asset allocation behaviors can more accurately reveal the real monetary conditions than the measures based on the macro monetary variables. Using the American sectoral data and the standard procedure of calibration, we finally construct the Stock-Flow Consistent Analysis (SFCA) model with six sectors and 83 equations, according to the characters of American economy. Followed by standard dynamic simulation procedures, we analyze the effect and relative importance of various external shocks, such as real economy variables, expectation variables and policy instruments, on the American's household sector's change of assets allocation behavior.As shown by the results of simulation, we found that, (1) on the real economy aspects-the potential growth rate of GDP, the increase of wage bargaining power between labors and firms, the increase of productivity, increase of production utilization-all had significant effects on households' assets allocation and adjustment behaviors, and led an macro monetary excess liquidity condition at several beginning periods, but had a reversal afterward, and eventually reverted to the original equilibrium path after many periods. The decisions of firms' external financing ratio and profit retained ratio had little effects on household' s liquidity assets, but had a significant effect on their demands of bonds and stocks. (2) on the aspects of expectations, the increase of parameters of inflation expectation and future stock price expectation led to an obvious shortage of liquidity firstly and came back to their original equilibrium paths, meanwhile the increase of parameters of GDP expectation and productivity expectation had opposite effects. The simulations of monetary policy and fiscal policy shown that, the increase of statutory reserve ratio settled by the central bank and excess reserve ratio adjustment of commercial banks had significantly effects on controlling excess liquidity, only in the short term, the effects would disappear soon in the long run. On the side of fiscal policy, an increase in tax rate significantly decreased the excess liquidity, but the active government spending had little effects on the macro monetary liquidity.