DP11444 The I Theory of Money

Author(s): Markus K Brunnermeier, Yuliy Sannikov
Publication Date: August 2016
Keyword(s): (Inside) Money, Endogenous Risk Dynamics, Financial Frictions, Monetary Economics, Paradox of Prudence
JEL(s): E32, E41, E44, E51, E52, E58, G01, G11, G21
Programme Areas: Financial Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11444

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.