Liquidity and Business Cycles—With Occasional Disruptions
Semmler W. Rosario G.R.P. Koçkesen L.
December 2023Multidisciplinary Digital Publishing Institute (MDPI)
Econometrics
2023#11Issue 4
Some financial disruptions that started in California, U.S., in March 2023, resulting in the closure of several medium-size U.S. banks, shed new light on the role of liquidity in business cycle dynamics. In the normal path of the business cycle, liquidity and output mutually interact. Small shocks generally lead to mean reversion through market forces, as a low degree of liquidity dissipation does not significantly disrupt the economic dynamics. However, larger shocks and greater liquidity dissipation arising from runs on financial institutions and contagion effects can trigger tipping points, financial disruptions, and economic downturns. The latter poses severe challenges for Central Banks, which during normal times, usually maintain a hands-off approach with soft regulation and monitoring, allowing the market to operate. However, in severe times of liquidity dissipation, they must swiftly restore liquidity flows and rebuild trust in stability to avoid further disruptions and meltdowns. In this paper, we present a nonlinear model of the liquidity–macro interaction and econometrically explore those types of dynamic features with data from the U.S. economy. Guided by a theoretical model, we use nonlinear econometric methods of a Smooth Transition Regression type to study those features, which provide and suggest further regulation and monitoring guidelines and institutional enforcement of rules.
banking crisis , complex dynamic models , estimation of limit cycles , regime change model , smooth transition regression models
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Department of Economics, The New School for Social Research, New York, 10003, NY, United States
Department of Economics, Bielefeld University, Bielefeld, 33615, Germany
Department of Economics, Nazarbayev University, Astana, 010000, Kazakhstan
Department of Economics
Department of Economics
Department of Economics
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