Liquidity becomes an issue whenever the marginal opportunity cost associated with holding cash exceeds the marginal reduction in risk achieved by holding cash. It is almost always nominally safer to hold cash, except in cases of hyperinflation, but the real cost of liquidity is equal to the returns that can be realized by employing the cash productively. In macroeconomic terms, too much liquidity serves to distort financial markets and misallocates capital.

In finance and economics, liquidity refers to the ease of acquiring cash or the amount of cash-like instruments on hand. Liquid investments are those that can be bought and sold with ease; liquid assets are readily convertible into cash. The economy is said to be more liquid when the cost of borrowing money, or real interest rates, is low and the pool of loanable funds is large.

Ultimately, the right level of liquidity comes down to personal time preference for investors, financial objectives and reality for businesses, and the supply and demand for loans for central bank policy. Individuals who hold liquid currency value it for the security it provides against unexpected costs and its ability to satisfy present consumption. Investors who want the flexibility to jump in and out of markets tend toward liquid assets; this is one of the primary advantages of the hyper-liquid forex market. Businesses want to show competitive liquidity ratios to potential lenders and investors. Everyone needs a certain level of liquid security.

In all of these cases, however, the holders of cash are giving up future returns in exchange. Cash held cannot be invested and, short of experiencing a deflationary period, does not gain any value over time. It is a risk-reward trade-off and one that is different for each individual consumer, investor or firm. Investing or loaning funds reduces present consumption, or liquidity, in exchange for greater future consumption and a higher degree of risk.