Transmission Mechanisms of Liquidity Shocks

Liquidity can be analyzed from four dimensions——market liquidity,financing liquidity,balance sheet liquidity and liquidity needs.The interaction of the four dimensions creates five transmission mechanisms,which are borrower's asset and liability effect,credit crunch effect,financial institution run effect,credit contagion effect,and the aversion effect of uncertainty.Single liquidity shock can evolve to systematic liquidity shocks through the five transmission mechanisms,which conduct the liquidity shock of capital market to other financial markets.The five transmission mechanisms can mutually reinforce and finally form a cycle of liquidity.In order to prevent or reduce the impact of liquidity crisis on the economic and financial system,it is necessary to raise the ability of individual financial institutions to deal with liquidity shocks,as well as improve the infrastructure of financial system.When necessary,central banks should inject liquidity to the market to enhance confidence.