Working Paper: NBER ID: w22533
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 policy; financial intermediaries; inside money; economic stability; macroprudential policy
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 |
|---|---|
| Accommodative monetary policy (E52) | Boosts asset prices (G19) |
| Boosts asset prices (G19) | Recapitalizes balance sheet-impaired sectors (O16) |
| Recapitalizes balance sheet-impaired sectors (O16) | Reduces liquidity pressures (E44) |
| Recapitalizes balance sheet-impaired sectors (O16) | Reduces disinflationary effects (E31) |
| Undercapitalized intermediaries (F65) | Shrink lending activities (G21) |
| Shrink lending activities (G21) | Exacerbates disinflation (E31) |
| Shrink lending activities (G21) | Increases value of outside money (E49) |
| Effective monetary policy (E52) | Reduces systemic risk (G28) |
| Effective monetary policy (E52) | Improves overall welfare (D69) |
| Monetary policy (E52) | Economic outcomes (F69) |
| Monetary policy (E52) | Capacity to diversify idiosyncratic risk (G19) |
| Capacity to diversify idiosyncratic risk (G19) | Impact on risk premia (G19) |