##cial firms, balance sheet liquidity is often measured by the short - term liquid assets on their balance sheet. for banks, which must manage their liquidity very closely, balance sheet liquidity is reflected in a detailed breakdown, by maturity, of their assets and liabilities – especially those coming due in the short term. the ability of banks to fund themselves is often referred to as funding liquidity. the common element in these concepts is that liquidity is the ability to obtain cash – either by turning assets into cash on short notice or by having access to credit. i'll focus largely on the first two concepts, macroeconomic and market liquidity. in each case, i'll suggest why liquidity matters, both in a general sense and to policy - makers, and i'll describe how it's measured. then, i'll discuss the state of liquidity, in its various forms, both before the summer turbulence and after. i'll conclude by describing the current situation and saying a few words about the bank of canada's role with respect to each type of liquidity. k. warsh. " market liquidity : definitions and implications. " speech to the institute of international bankers annual washington conference, in washington, d. c., march 2007. available at : http : / / www. federalreserve. gov / newsevents / speech / warsh20070305a. htm. macroeconomic liquidity as i noted earlier, i am using the term macroeconomic liquidity to refer to " overall monetary conditions. " any economy, whether national or global, functions best when there's enough – but not too much – liquidity. so, how much is the right amount in a national economy? the answer depends on the central bank's objectives. in canada, our monetary policy objective is to meet the inflation target. this goal has been achieved with considerable success since the target was introduced in 1991. in general, when inflation is tending to remain on target, liquidity is adequate. if there were too much liquidity in the economy, inflation would threaten to rise above target. if there were too little, inflation would tend to fall below it. to put this same notion in different terms, the risk of having too much, or too little, liquidity in our domestic economy is essentially the same risk that is posed by future inflation being higher or lower than the target. the key indicators of macroeconomic liquidity

effect on the real economy. that, in brief, is our framework. now, let ’ s look at high household debt, a key vulnerability we analyzed in the december issue of the fsr. 6 key vulnerability : household indebtedness canada was spared some of the most serious negative consequences of the global financial crisis because of our strong financial regulatory and supervisory framework and the effectiveness of our policy response. this response included a reduction in the policy interest rate by the bank of canada to support aggregate demand and help achieve our inflation target. 7 as a result of these policies, the canadian economy recovered relatively quickly, supported by solid growth in household spending that was funded by household income growth and borrowing. 8 the buildup of household debt, however, has increased the vulnerability of the economy and the financial system to adverse shocks to incomes and interest rates. 9 with high indebtedness or elevated leverage – an important indicator of vulnerability in the financial system – the household sector is less resilient. during times of stress, people with higher debt will typically cut back on their spending disproportionately more than those with less or no debt. this means that high household indebtedness can amplify the impact of a shock. in more extreme cases, adverse shocks could lead to an increase in household defaults, which would mean losses for banks, other lenders and mortgage insurers. in the worst case, if the losses were extensive and spillovers were large, the increase in stress could potentially deplete the capital buffers built into the financial system to absorb losses, impairing its functioning, with large negative effects on economic activity. market infrastructures, which are the systems that facilitate the clearing, settlement and recording of payments, securities and derivatives or other financial transactions among participating entities. vulnerabilities in these different sectors are measured along various dimensions, such as the degree of leverage, complexity, and liquidity and maturity transformation, as well as the behaviour of asset prices. while these elements are part of the normal functioning of the financial system, they may make the system vulnerable if they become excessive. in addition, we review the external exposures of the sectors and their degree of interconnectedness across the canadian financial system. for example, the interbank market is an important source of funding, but it could rapidly transmit funding problems through the system in the event of a financial shock. g. cateau, t. roberts and j. zhou, “ ind