Impacts on Liquidity - ECO316 Essay Example | Topics and Well Written Essays - 500 words

Impacts on Liquidity - ECO316 - Essay Example This consequently led to the financial crisis and eventually a shortage of liquidity due to wrong policies. Excessive savings were required to fight the crisis and ensure that no financial institution faced liquidity issues. United States first followed the expansionary policy where it experienced an increase in the monetary base. To avoid excessive liquidity in the market, US implemented contractionary policy to control the rate at which the monetary base was increasing. The financial markets yet had liquidity and were not insolvent. Adding the role of government, the budget deficits have been soaking up the savings. Consequently, this has hindered the growth of the market and economy. The government budget deficits have created solvency issues not only for the government but also for the whole nation. The impact of government spending is less productive as compared to the measures undertaken by the central bank, Fed. Government budget deficits do lead to difficulties in getting investments, and it does cause solvency issues, but that can be fought with a right monetary policy by the central bank, Fed. Falling government budget deficits do support and strengthen the fact that there was too much liquidity in the financial markets. However, it does not mean the government’s declining budget deficits had stronger influence on increasing liquidity. Federal Reserve (Fed) has the strongest ability to influence the monetary base which consequently determines the level of liquidity available in the financial markets. By 2006, Federal Reserve (Fed) had been able to increase liquidity in the financial markets. In fact, there was too much liquidity, and to control the liquidity level, by the fall of 2006, Federal Reserve (Fed) introduced contractionary monetary policy. This is when US budget deficits started declining. The rapidly increasing monetary base and levels of liquidity were consequences of the monetary policy and measures taken by the