How does asset market liquidity affect the real economy? A quantitative assessment of the transmission channels

Miroslav Gabrovski, Athanasios Geromichalos (), Lucas Herrenbrueck, Ioannis Kospentaris and Sukjoon Lee ()
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Athanasios Geromichalos: University of California Davis
Sukjoon Lee: New York University Shanghai

No 202501, Working Papers from University of Hawaii at Manoa, Department of Economics

Abstract: The corporate bond market provides a vital avenue for firms to cover their borrowing needs. Moreover, the ease with which corporate bonds can be (re)traded in secondary markets affects their liquidity and, effectively, the rate at which corporations can borrow. However, the literature has also pointed out that a well-functioning secondary market can depress money demand and hurt economic activity. We perform a careful quantitative analysis of the channels through which secondary market liquidity affects the real economy in the context of a New Monetarist model. We find that a deterioration in secondary market liquidity has a negative but modest impact on output and unemployment. This small net effect, however, conceals much larger underlying forces that operate in opposite directions and largely offset each other. We also show that the results of our decomposition exercise depend on the inflation rate. Our findings highlight the importance of studying investor portfolios together with asset prices to fully capture the interaction between financial markets and the real economy.

Keywords: Search frictions; Unemployment; Corporate bonds; Money; Liquidity; Inflation 6. E24; E31; E41; E44. (search for similar items in EconPapers)
JEL-codes: E24 E31 E41 E44 (search for similar items in EconPapers)
Date: 2025-04
New Economics Papers: this item is included in nep-dge and nep-fdg
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