You are on page 1of 1

Liquidity Effects Channel

In the liquidity effects channel of monetary transmission view, balance sheet effects take place through impact on consumers desire to spend unlike other channels where impact was depending on lenders desire to lend. Because of reservations, subjectivity and asymmetric information about their quality, there is lack of liquidity for consumer durables and housing assets. If, during bad times, consumers needed to sell these to raise money, they would suffer a big loss because they could not retrieve the full value of these assets in a distress sale. On the contrary, if consumers held financial assets (such as money in the bank, stocks, or bonds) which are fairly liquid, they could easily sell them quickly for their good market value and raise the cash. Hence if consumers anticipate a higher likelihood of finding themselves in financial distress, they would be holding fewer illiquid consumer durable or housing assets and prefer to own more liquid financial assets. A consumers balance sheet can have an important influence on his or her likelihood of suffering financial distress. Specifically, when consumers have higher proportion of financial assets relative to their debts, their probability and perception of the probability of financial distress is low, and they will invest more on consumer durables or housing. When stock prices or value of equity rise, the value of financial assets rises as well; consumer durable expenditure will also rise because consumers have a more secure financial position and a lower estimate of the likelihood of suffering financial distress. M Ps financial assets likelihood of financial distress Consumer durable and housing expenditure Y