Working Paper: NBER ID: w18102
Authors: Markus K. Brunnermeier; Thomas M. Eisenbach; Yuliy Sannikov
Abstract: This article surveys the macroeconomic implications of financial frictions. Financial frictions lead to persistence and when combined with illiquidity to non-linear amplification effects. Risk is endogenous and liquidity spirals cause financial instability. Increasing margins further restrict leverage and exacerbate downturns. A demand for liquid assets and a role for money emerges. The market outcome is generically not even constrained efficient and the issuance of government debt can lead to a Pareto improvement. While financial institutions can mitigate frictions, they introduce additional fragility and through their erratic money creation harm price stability.
Keywords: financial frictions; macroeconomics; business cycles; liquidity; stability
JEL Codes: A23; E1; E3; E4; E5; G01; G1; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| initial negative shock to entrepreneurial net worth (L26) | increased financial frictions (G19) |
| increased financial frictions (G19) | reduced investment (G31) |
| reduced investment (G31) | lower output (E23) |
| increased financial frictions (G19) | lower output (E23) |
| deteriorating asset prices (G19) | further declines in net worth (G51) |
| liquidity spirals (E44) | exacerbated downturn (F44) |
| adverse shocks (E32) | higher degree of instability in the financial system (F65) |