Working Paper: CEPR ID: DP11444
Authors: Markus K. Brunnermeier; Yuliy Sannikov
Abstract: A theory of money needs a proper place for financial intermediaries. Intermediaries diversify risks and create inside money. In downturns, micro-prudent intermediaries shrink their lending activity, fire-sell assets and supply less inside money, exactly when money demand rises. The resulting Fisher disinflation hurts intermediaries and other borrowers. Shocks are amplified, volatility spikes and risk premia rise. Monetary policy is redistributive. Accommodative monetary policy that boosts assets held by balance sheet impaired sectors, recapitalizes them and mitigates the adverse liquidity and disinflationary spirals. Since monetary policy cannot provide insurance and control risk-taking separately, adding macroprudential policy that limits leverage attains higher welfare.
Keywords: monetary economics; inside money; endogenous risk dynamics; paradox of prudence; financial frictions
JEL Codes: E32; E41; E44; E51; E52; E58; G01; G11; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy (E52) | financial intermediaries (G20) |
| financial intermediaries (G20) | inside money (E51) |
| inside money (E51) | money demand (E41) |
| money demand (E41) | disinflation (E31) |
| shrinking of intermediaries' balance sheets (F65) | inside money (E51) |
| monetary policy (E52) | assets held by balance sheet-impaired sectors (G32) |
| monetary policy (E52) | risk perceptions and behaviors of intermediaries (G41) |
| anticipated monetary policy loosening (E52) | prices and returns on assets (G12) |
| monetary policy (E52) | welfare (I38) |
| monetary policy cannot separately provide insurance and control risk-taking (E61) | necessity of macroprudential policies (E60) |