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Discussion Paper Details

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Title: The I Theory of Money

Author(s): Markus K Brunnermeier and Yuliy Sannikov

Publication Date: August 2016

Keyword(s): (Inside) Money, Endogenous Risk Dynamics, Financial Frictions, Monetary Economics and Paradox of Prudence

Programme Area(s): Financial Economics and Monetary Economics and Fluctuations

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.

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Bibliographic Reference

Brunnermeier, M and Sannikov, Y. 2016. 'The I Theory of Money'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11444