By Goldman Sachs Economics Research
Creating an effective Capital Markets Union
The European Commission recently identified three key objectives for the Capital Markets Union (CMU) it proposes to create in Europe: (1) providing wider access to market sources of finance; (b) facilitating an easier flow of institutional and retail investment into capital markets; and (c) improving market functioning and liquidity.
Measuring market liquidity
In this European Economics Analyst, we look more closely at market functioning and effectiveness. We set out to construct measures of market activity and market liquidity using tools developed in the literature on financial market microstructure. These measures can then be monitored through time and across countries as indicators of how well markets are functioning.
Market liquidity is generally lower in Europe than US
We analyse the money market, the sovereign debt market and the corporate bond market. We conclude that: (i) owing to lower market liquidity, transaction costs are generally higher in the Euro area than in the US; (ii) banks have played a more important role in determining market liquidity in the Euro area than in the US, particularly in the corporate bond market; and (iii) the ECB’s intermediation of financial flows across its own balance sheet via the non-standard policies implemented during the financial crisis substituted for market activity.
Improving market functioning essential to CMU
The ongoing debate on the Capital Markets Union has highlighted the need to improve market access for both issuers and investors. But we also need to understand if the markets are functioning effectively. Constructing indicators of market liquidity is an important first step in taking a closer look at the functioning of European financial markets in order to better understand their strengths and shortcomings in light of international and historical experience.