Market liquidity: a cause for concern?

The issue of whether there has been a decline in market liquidity (the ease with which financial assets can be bought and sold without a large impact on price), and whether this is due to regulatory reforms introduced after the global financial crisis, has been one of the most hotly debated topics in finance in recent times. In the euro area, low market liquidity was thought to be one of the factors behind the volatility in some sovereign debt markets in the spring and summer of 2015 and there may be grounds for thinking that episodes of volatility will occur more frequently than in the past. This article shows that assessing whether market liquidity has declined across asset classes is difficult, in part because market liquidity is typically gauged according to various criteria which may not always point in the same direction. Neither is it easy to ascribe a clear role to regulation in driving any reduction in liquidity, as other important cyclical and structural factors have also been at play. Nevertheless, market liquidity matters enormously for well-functioning financial markets that can support the economy by allocating capital efficiently. As market structures are constantly evolving, it is essential that we deepen our understanding of developments in market liquidity, including by gathering more data and improving the analysis of recent liquidity dynamics.