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Journal of Economic Literature: Vol. 49 No. 2 (June 2011)

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Illiquidity and All Its Friends

Article Citation

Tirole, Jean. 2011. "Illiquidity and All Its Friends." Journal of Economic Literature, 49(2): 287-325.

DOI: 10.1257/jel.49.2.287

Abstract

The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistic, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity, and analyzes how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyzes optimal combinations thereof; it stresses the need for macro-prudential policies. ( JEL E44, G01, G21, G28, G32, L51)

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Authors

Tirole, Jean (Toulouse School of Economics)

JEL Classifications

E44: Financial Markets and the Macroeconomy
G01: Financial Crises
G21: Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G28: Financial Institutions and Services: Government Policy and Regulation
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
L51: Economics of Regulation


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