>FLASH ECONOMICS (ECONOMIC RESEARCH)

Where will liquidity flow to?

Many questions are posed concerning the use that will be made of the very abundant liquidity created especially since the beginning of the crisis, but the use will differ depending on the nature of this liquidity and its holders:

■ banks hold very abundant surplus reserves with the central banks; a concern for avoiding additional consumption of equity, together with weak credit demand, could lead them to invest in government securities to profit from the steep yield curve, which would prevent long-term interest rates from rising despite fiscal deficits;

■ households hold very large monetary assets (deposits, money-market securities and funds, etc.) on which the return is virtually zero; when pulling out of a crisis, their usual behaviour is to reinvest in equities, which should benefit the stock market when the economy recovers;

■ investors and funds have very plentiful cash reserves; they are reluctant to go back into government securities, due to low yields and the risks of a rise in interest rates; they will probably first go back into assets offering potentially high returns: credit (which is already largely the case), emerging markets, commodities and “toxic” assets, as has already been seen since March 2009.

The question of re-investment of liquidity in the financial markets and excess liquidity is very important for investors: what asset classes will profit from this reinvestment; will it cause further asset price bubbles?

But, to answer this question, one must be more precise and distinguish between the various types of liquidity (monetary base, money supply) and the various holders of liquidity (banks, households, investors). Note that monetary policy accounts for the increase in all forms of liquidity: conventional monetary policies (asset purchases from banks and repos) increase the monetary base (Charts 1A and B) and bank liquidity; unconventional monetary policies consist in buying assets in the financial markets (which is at present very widespread in the United States, Table 1), thereby providing the sellers with liquidity (money supply), of whatever kind; the accumulation of official reserves (Chart 2) provides liquidity (money supply) to the sellers of foreign-currency assets purchased by the central bank.

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