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Reinterpreting recent crises through the lens of global liquidity cycles cannot hide the fact that the crises themselves have their origins in more fundamental “fault lines”. Liquidity fluctuation and cycles simply exacerbate these underlying weaknesses. The recent financial crisis revealed gaps in regulation and supervision, especially in segments such as the shadow banking system, as well as the lack of a macro-prudential approach to financial supervision. Finally, the debt crisis in the euro area has its roots in insufficient fiscal discipline and, even more importantly, in divergent productivity trends among the Member States. Such divergence sows the seeds of balance-of-payment imbalances and ultimately leads to a sudden stop of capital inflows into peripheral countries. Obviously, adequate policy responses will have to focus primarily on these structural issues.
At the same time, it is essential to adopt measures that can break the self-reinforcing interaction between risk appetite and liquidity in order to avoid further financial crises. Three avenues that merit further reflection:
Progress along these three avenues would help to provide a consistent policy framework for addressing global liquidity.