Many economic problems relate closely to the ability of businesses to get credit, sell assets and find investors. All of these needs closely link to the availability of credit in the larger financial markets, a concept often referred to as aggregate liquidity. Information about aggregate liquidity is important to investors, as it has a substantial impact on economic growth and development.
In economics, liquidity refers to the ability to convert one asset into another or to use assets to meet obligations. The liquidity of an asset is high if it can easily change into other assets. Currency, for example, is the asset with the highest liquidity because it easily exchanges for goods and services. Other high-liquidity assets include stocks, bonds, derivatives or other financial instruments, such as commodity futures contracts, that investors can easily sell for cash. Less liquid assets are items that are more difficult to sell, such as real estate, cars or factories.
Aggregate liquidity refers to the ease of execution for financial transactions for everyone in the entire market. This is highly dependent on the availability of credit in the markets and the size of the money supply. Monetary policy, the decision-making of central banking institutions such as the Federal Reserve, and market conditions all affect aggregate liquidity. Macroeconomists often study aggregate liquidity in depth because the ability to settle transactions is often a determinant of economic productivity and growth.
Implications for Economic Growth
Aggregate liquidity has a major effect on market conditions. If the amount of money available to borrowers in the market is small or shrinking, businesses will have a harder time financing new investments and paying debts. This results in decisions to call in loans or cut costs, both of which can result in further decreases of the money supply. If the market takes no action to expand access to credit, liquidity restraints on spending, hiring and investment can negatively affect economic growth.
Impacts on Business Management
Both aggregate liquidity and the business's liquidity can have a substantial effect on management. A business's access to credit is not the only factor affected by aggregate liquidity constraints. Aggregate liquidity also determines the ability and confidence of consumers to borrow and spend, acting as a predictor of demand. In addition, a business that regularly carries a large balance of illiquid assets, such as real estate or inventory, is more likely to experience bankruptcy if aggregate liquidity declines. On the other hand, businesses with more illiquid assets become safer and more advantageous investments when liquidity expands.