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Impacts on Liquidity Essay


Liquidity is defined in simple terms as the monetary supply in the financial market in a specific period of time. The manipulation of open market operations affects the level of liquidity in the financial market (Hubbard, 2008). It is not advisable to ignore the kind of impact of open-market operations on the level of liquidity.

It is not easy to determine the most suitable level of liquidity required by financial markets without careful analysis. It is necessary for a financial market to have some level of liquidity because lack of it leads to severe economic consequences (Hubbard, 2008).

A financial market without liquidity will definitely experience less market transactions and high interest rates which are not good for economic growth. A financial market with an excessive amount of liquidity is bound to experience high inflation rates (Graham, 2001).

The size of a budget deficit affects the level of liquidity in the financial market

The falling over of the Federal government budget deficit weakens the argument that there is too much liquidity in the financial market (Graham, 2001). The economic growth of a country depends on its level of deficit spending. The Federal government budget deficit fall means that deficit spending goes down.

The level of liquidity in the financial market can only rise with an increase in deficit spending. Deficit spending is therefore very critical in an economic recession (Graham, 2001). The level of liquidity in the financial market entirely depends on the Federal government budget deficit. A large budget deficit means that most of the government spending will depend on borrowed money in order to cover the deficit.

This normally leads to a high level of liquidity in the financial market (Hubbard, 2008). A very small budget deficit means that the level of deficit spending goes down. Deficit spending leads to economic growth because the borrowed money is used to increase production and at the same time create employment opportunities.

The Federal government can decide to pump money into the economy as a way of covering its budget deficit (Hubbard, 2008). This increases the level of liquidity in the financial market and promotes economic growth. The falling over of the Federal government budget deficit means that the national income and consumption goes down.

The level of national income and consumption reflects the level of liquidity in the financial market (Hubbard, 2008). A decline in deficit spending leads to lack of liquidity in the financial market. All forms of deficit financing increases the level of monetary supply with a possible risk of inflation. A fall in the budget deficit means that the Federal government will rely on income from taxes to finance its operations.

A fall in the Federal government budget deficit leads to an increase in currency demand which in turn drains liquidity (Hubbard, 2008). Financial institutions such as banks are normally forced to demand for their reserves from the central bank due to lack of liquidity in the financial market.

The credit potential of banks is normally reduced by the demand for excess reserves. Budget deficit spending enables the public to be in a better position to save money and in the process reduce currency demand (Hubbard, 2008). The level of liquidity goes down with an increase in currency demand.

A lower budget deficit reduces government spending on infrastructure and other social services hence making it impossible for the financial market to have enough liquidity (Graham, 2001). The Federal government can decide to reduce its spending in order to have a low budget deficit but this affects economic growth.

A low budget deficit may seem good in the initial stages but it affects the monetary supply in the financial market. There is no way that the level of liquidity in the financial market can increase with a falling budget deficit (Graham, 2001). The main argument is that a falling Federal government budget deficit is not good for the economy.

An economy that is doing well depends on deficit spending. Deficit spending stimulates economic growth through tax cuts and creation of employment opportunities (Graham, 2001). The Federal government can have the incentive to overspend in an economic recession because of a reasonable budget deficit. The need to have enough liquidity in the financial market is the reason why the U.S government has been overspending.

In conclusion, a falling Federal government budget deficit does not in any way increase the level of liquidity in the financial market. Deficit spending ensures that there is enough monetary supply and in the process stimulates economic growth (Hubbard, 2008). A budget deficit that is falling over tends to restrict government spending.

The resulting effect of a low budget deficit is an increase in currency demand due to lack of liquidity. A falling budget deficit leads to high interest rates and less financial transaction (Hubbard, 2008). The two effects of a low budget deficit are responsible for the low liquidity level in the financial market. Federal governments overspend intentionally for economic sustainability (Hubbard, 2008). There is a very strong correlation between budget deficits and the level of liquidity in a financial market.

References

Graham, J. (2001). Firm value and optimal levels of liquidity. New York, NY: Routledge.

Hubbard, R.G. (2008). Money, the financial system, and the economy (6th ed.). Boston: Pearson Addison Wesley.

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IvyPanda. (2019, April 17). Impacts on Liquidity. Retrieved from https://ivypanda.com/essays/impacts-on-liquidity/

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"Impacts on Liquidity." IvyPanda, 17 Apr. 2019, ivypanda.com/essays/impacts-on-liquidity/.

1. IvyPanda. "Impacts on Liquidity." April 17, 2019. https://ivypanda.com/essays/impacts-on-liquidity/.


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IvyPanda. "Impacts on Liquidity." April 17, 2019. https://ivypanda.com/essays/impacts-on-liquidity/.

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IvyPanda. 2019. "Impacts on Liquidity." April 17, 2019. https://ivypanda.com/essays/impacts-on-liquidity/.

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IvyPanda. (2019) 'Impacts on Liquidity'. 17 April.

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