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Theoretical research on the influence of monetary liquidity on asset prices
the change trend of monetary liquidity reflects the loose or tight monetary environment, and the change characteristics of asset prices in different monetary policy environments are the concerns of every institutional investor, which has important practical significance
the economic meaning of money liquidity
money liquidity reflects a basic situation of money supply. At the macro-economic level, we often directly understand liquidity as the total amount of money and credit with different statistical caliber. The deposits of residents and enterprises in commercial banks, as well as bank acceptance bills, short-term treasury bonds, policy financial bonds, money market funds and other high liquidity assets, can be classified into different macro liquidity categories according to the needs of analysis. Indicators to measure the total amount of money include M0, M1, M2, m3, etc. M0 refers to cash in circulation“ M1, in a narrow sense, is usually composed of cash circulating outside the banking system, held by the monetary public and current deposits of commercial banks“ M2, the generalized currency, has added the fixed deposit and savings deposit of commercial banks on the basis of M1. M3 adds the liabilities of non bank financial intermediaries on the basis of M2. Broad money covers a variety of monetary forms held by different financial institutions, better adapt to the needs of modern economy, has become an important indicator of monetary authorities in developed countries.. The Central Bank of China regularly publishes the statistics of the narrow money supply M0 and M1, as well as the broad money supply m3
the quantity theory of money points out the relationship between money supply, economic activity and price level, which can be expressed by Fisher Equation: MV = Pt. Where m is money supply; V refers to the velocity of money circulation; P is the average price level; T refers to the trading volume of goods and services. The theory assumes that the velocity of money circulation (V) and trading volume (T) will not change in the short term. In this way, the increase of money supply (m) will cause the increase of price level (P) and lead to inflation. The specific form of liquidity is deeply affected by the changes of financial institutions and their actual activities. Its complexity and variability may make the relationship between money and economy understood by the traditional monetary quantity theory unstable
in recent years, with the rapid development of capital market and its derivatives market, many economists have proposed that money is used to meet the needs of all economic activities, including not only commodities in circulation, but also assets. Therefore, Fisher Equation should be modified to MV = Pt + s, where s represents the demand of capital market for money. Another criticism of the traditional money quantity theory is that many scholars believe that the velocity of money circulation (V) changes according to the environment of economic and commercial activities and should not be assumed to remain completely unchanged. These suggestions for the improvement of money quantity theory reflect the development and changes of economic activities, and the basic laws revealed by money quantity theory are worth learning and exploring
the changing trend of monetary liquidity reflects the loose or tight monetary environment. The economic definition of excess liquidity is: the positive deviation between the actual amount of money in circulation and the amount of money needed in the state of economic equilibrium. Excess liquidity can be understood as money supply exceeding the need to maintain long-term price stability. According to the definition of excess liquidity, when we measure the excess liquidity, we first estimate the theoretical total amount of money circulation under the state of economic equilibrium, and then calculate the difference between the actual total amount of money and obtain the specific value of excess or shortage. In practice, it is difficult to determine what level of money supply is the most reasonable, and there are many debates in economic theory. Therefore, the excess monetary liquidity we observed in practice is not an absolute excess, but a relative excess, that is, the development trend of monetary liquidity easing or tightening
we can use the ratio of money growth rate to GDP growth rate to measure the change trend of money liquidity. Assuming that the speed of money circulation remains unchanged, if the growth rate of money supply and circulation speed exceeds the growth rate of physical goods and prices, liquidity tends to be loose, otherwise it tends to be tight. In addition, we can measure liquidity by the real interest rate level which represents the price of money flow. When the interest rate falls, the liquidity tends to be loose, and vice versa
theoretical explanation of the effect of monetary liquidity on asset prices
maintaining a stable price level has always been the focus of monetary policy authorities and one of the ultimate goals of monetary policy. The level of asset prices has attracted the attention of monetary policy authorities, which can be traced back to the US economic bubble in 1920s and further reflected in the high-tech stock bubble in 90s. In the above two periods (1923-1929 and 1994-2000), the stock market index maintained an average annual growth of more than 20% in the two six years, accompanied by a low and stable inflation level and a high real GDP growth rate. At the same time, money circulation and loans also grow rapidly in these two stages. These facts show that asset prices have a great impact on the economy, and also reveal the high correlation between money supply and asset prices
in recent years, major countries in the world have successfully controlled the price level of consumer goods at a relatively stable level. US Federal Reserve Chairman Ben Hanke has pointed out that the focus of monetary policy in western countries has shifted from inflation to asset prices. Ferguson, former vice chairman of the Federal Reserve, also pointed out the reasons why monetary authorities pay attention to asset prices: because asset prices are an important part of the transmission mechanism of monetary policy, extraordinary changes in asset prices will lead to the failure of monetary policy to have an effective impact on economic activities; In addition, asset prices contain important information of monetary policy, which has the function of information disclosure. The central bank needs to ensure that the information disclosed is consistent with monetary policy. Monetary policy authorities pay more attention to asset prices, which reflects the important role of asset prices in the transmission mechanism of monetary policy. On the other hand, institutional investors are required to have a clearer understanding of the mechanism of money supply on asset prices and grasp the market trend
the impact of monetary liquidity on asset prices (including bond, stock and real estate prices) can be explained in the following aspects in theory:
firstly, the transmission mechanism of monetary policy tells us that the increase of liquidity will lead to the decrease of short-term interest rate; The decrease of short-term interest rate will lead to the decrease of long-term nominal interest rate; The fall of long-term interest rate causes the rise of stock price. The usual practice of the Fed's current monetary policy is to set a target interest rate according to the economic development and then adjust the supply of money (Federal Reserve) until the federal reserve rate reaches the target interest rate. Suppose that the Federal Reserve wants to rece interest rates, and the Federal Reserve chooses open market operation to buy bonds in the inter-bank market, which will lead to the rise of bond prices, the decline of return rate and the decline of interest rates. The behavior of the Federal Reserve increases the Federal Reserve that commercial banks can hold, increases the credit line of commercial banks, and finally increases the total amount of money in circulation in the economy
the level of interest rate can measure the price of money flow. The long-term interest rate and the short-term interest rate are closely linked, and the rate of return of bond assets (such as treasury bonds) is an important standard to measure the level of long-term interest rate. Therefore, the decline of bond interest rate when liquidity increases has a theoretical basis. The decrease of long-term interest rate reces the rate of return of debt assets. When the risk premium level of stock assets remains unchanged, it also reces the required rate of return of stock assets. The rection of the required rate of return on stock assets makes the current rate of return on stock assets exceed people's expectations. People put their own money into the stock to raise the stock price and rece the rate of return until it is consistent with the required rate of return. The price of the stock depends on the supply and demand of the stock. When calculating the intrinsic value of the stock (such as DDM model, the intrinsic value of the stock = future earnings / required rate of return), the future earnings or dividends of the company represented by the stock, as well as the interest rate and required rate of return, all play a decisive role Baks and Kramer, 1999)
the decrease of bond interest rate and the rise of stock price can also be explained by substitution effect. When the return rate of bond assets decreases, the capital will enter the stock market to obtain high return, until the capital's entry causes the stock price to rise, the return rate to decrease, and reaches the risk premium level of the stock assets. In addition, the loose monetary environment after the increase of liquidity improves the expectation of economic output and corporate profitability. The decrease of return and the increase of profit expectation will increase the intrinsic value of stock< Second, the theory of money quantity shows that when the liquidity of money is higher than the demand of economy, the price level will be raised. When the price index remains stable, asset prices will rise. This explanation is based on the wealth effect of excess money, which means that the wealth of residents measured by money increases; The wealth effect will be used to buy goods; If consumer prices remain stable, wealth will flow to assets and asset prices will rise. This explanation is also suitable for the relationship represented by modern money quantity theory (MV = Pt + s, s represents the need of assets for money). Money needs to meet the needs of all transactions, including not only consumer goods, but also assets. From the two largest stock market bubbles in the history of the United States (1923 to 1929, 1993 to 2000), price stability and asset prices rose sharply.
many scholars have carried out a lot of empirical analysis on the mechanism of the influence of monetary liquidity on asset prices based on the historical situation of the United States
Jensen and Johnson (1995) used the change in the direction of interest rate adjustment as the standard to measure the Fed's adoption of tight monetary policy or loose monetary policy. They analyzed the relationship between stock return and monetary environment in the United States from 1962 to 1991, and found that stock market is closely related to monetary environment. When monetary environment is loose, stock return is higher than when monetary environment is tight. Patelis (1997) used different monetary policy variables, and also came to the conclusion that monetary policy has a mechanism of action on the stock market. Mashall (1992) analyzed the quarterly data of the United States from 1959 to 1990. He measured monetary growth by comparing M1 growth rate with the proportion of consumption in GNP, and found that the real stock return rate was weakly positively correlated with monetary growth. Con ver, Jensen and Johnson (1999) found that the correlation between stock returns and U.S. monetary policy in some countries is very significant, and some are even stronger than that with domestic monetary environment. Baks and Kramer (1999) studied the mechanism of monetary liquidity in international markets. They found that the increase in currency liquidity in G-7 countries was consistent with the decline in real interest rates and the rise in real stock prices in G-7 countries. Bordo and Wheelock (2004) studied the major financial bubbles and financial crises in the history of the United States, and found that the formation of the financial bubble is generally accompanied by the excess growth of currency issuance and bank loans.
Ferguson (2005) used m3 growth rate to represent the change of money supply, and found that the growth of money liquidity is the same as that of stock price

1、 Calculation method:

F= π d1(0.33+0.97*d0* μ 0*P) For details, please refer to the following figure:

II. Brief introction of O-ring:

O-rings O-rings is a kind of rubber seal ring with circular section. Because its section is O-ring, it is called O-ring, also called O-ring. It began to appear in the mid-19th century, when it was used as a sealing element for steam engine cylinders