What is liquidity and why is it so important?
The publicly stated rationale for these large interventions is that liquidity dried up. Unfortunately, liquidity is one of those terms that means different things to different people. In the glossary to my Money and Banking textbook, I define liquidity as “the ease with which an asset can be turned into a means of payment such as money.” That is, when an asset is liquid it is easy to sell large quantities with out moving market prices. When something is illiquid, it is hard to sell. People don’t want to buy things that they can’t easily sell. If they are worried that a bond they are considering buying may be difficult or expensive to sell they will lower the price they are willing to pay, assuming anyone are still willing to buy it at all. For financial markets to function well, it must be cheap and easy to both buy and sell securities. When market liquidity dries up, the financial markets stop functioning. This form of liquidity might be better labeled “market liquidity” as distinct f
