Macro & Finance

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The I Theory of Money, Brunnermeier, Markus K., and Sannikov Yuliy , (In Progress) Abstracti_theory.pdfi_theory_slides.pdfi_theory2.pdf

A theory of money needs a proper place for financial intermediaries. Intermediaries create money by taking deposits from savers and investing them in productive projects. The money multiplier depends on the size of intermediary balance sheets, and their ability to take risks. In downturns, as lending contracts and the money multiplier shrinks, the value of money rises. This leads to a Fisher deflation that hurts borrowers and amplifies shocks. An accommodative monetary policy in downturns, focused on the assets held by constrained agents, can mitigate these destabilizing adverse feedback effects. We devote particular attention to interest rate cuts, and study the potential for such policies to create moral hazard.

A Macroeconomic Model with a Financial Sector, Brunnermeier, Markus K., and Sannikov Yuliy , American Economic Review, (In Press) Abstractmacro_finance_slides.pdfmacro_finance.pdf

This paper studies the full equilibrium dynamics of an economy with financial frictions. Due to highly non-linear ampli cation e ects, the economy is prone to instability and occasionally enters volatile episodes. Risk is endogenous and asset price correlations are high in down turns. In an environment of low exogenous risk experts assume higher leverage making the system more prone to systemic volatility spikes - a volatility paradox. Securitization and derivatives contracts leads to better sharing of exogenous risk but to higher endogenous systemic risk. Financial experts may impose a negative externality on each other by not maintaining adequate capital cushion.

Macroeconomics with Financial Frictions: A Survey, Brunnermeier, Markus K., Eisenbach Thomas, and Sannikov Yuliy , (In Press) Abstractslides.pdfsurvey_macrofinance.pdf

This article surveys the macroeconomic implications of financial frictions. Financial frictions lead to persistence and when combined with illiquidity to non-linear amplification e ects. Risk is endogenous and liquidity spirals cause financial instability. Increasing margins further restrict leverage and exacerbate the downturn. A demand for liquid assets and a role for money emerges. The market outcome is generically not even constrained ecient 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.

Liquidity Mismatch, Brunnermeier, Markus K., Gorton Gary, and Krishnamurthy Arvind , Risk Topography, Chicago, (In Press) liquidity_mismatch_slides.pdf
Redistributive Monetary Policy, Brunnermeier, Markus K., and Sannikov Yuliy , Jackson Hole Symposium, 1 September 2012, Jackson Hole, (In Press) AbstractRedistributive Monetary Policy.pdfJackson Hole 2012 Presentation.pdfThree Stability Concepts.pdfJackson Hole Symposium

Liquidity and deflationary spirals self-generate endogenous risk and redistribute wealth. Monetary policy can mitigate these effects and help rebalance wealth after an adverse shock, thereby reducing endogenous risk, stabilizing the economy, and stimulating growth. The redistributive channel differs from the classic Keynesian interest rate channel in models with price stickiness. Central banks assume and redistribute tail risk when purchasing assets or relaxing their collateral requirements. Monetary policy (rules) can be seen as a social insurance scheme for an economy beset by financial frictions. As with any insurance, it carries the cost of moral hazard. Redistributive monetary policy should be strictly limited to undoing the redistribution caused by the amplification effects and by moral hazard considerations.

Risk Topography, Brunnermeier, Markus K., Gorton Gary, and Krishnamurthy Arvind , NBER Macroeconomics Annual 2011, Volume 26, p.149-176, (2012) Abstractrisk_topography.pdfrisk_topography_slides.pdf

The aim of this paper is to conceptualize and design a risk topography that outlines a data acquisition and dissemination process that informs policymakers, researchers and market participants about systemic risk. Our approach emphasizes that systemic risk (i) cannot be detected based on measuring cash instruments, e.g., balance sheet items or ratios such as leverage and income statement items; (ii) typically builds up in the background before materializing in a crisis; and (iii), is determined by market participants’ endogenous response to various shocks. Our measurement system asks that regulators elicit from market participants their (partial equilibrium) risk as well as liquidity sensitivities (our response indicator) with respect to major risk factors and liquidity scenarios. General equilibrium responses and economy-wide system effects can be calibrated using this panel data set.

Do Wealth Fluctuations Generate Time-Varying Risk Aversion? Micro-Evidence on Individuals' Asset Allocation, Brunnermeier, Markus K., and Nagel Stefan , The American Economic Review, Volume 98, Number 3, p.713-736, (2008) Abstracttime_varying_riskaversion.pdf

Wealth shocks do not change the fraction individuals invest in risky assets, suggesting that individuals' risk aversion is not time-varying.

We use data from the Panel Study of Income Dynamics to investigate how households' portfolio allocations change in response to wealth fluctuations. Persistent habits, consumption commitments, and subsistence levels can generate time-varying risk aversion with the consequence that when the level of liquid wealth changes, the proportion a household invests in risky assets should also change in the same direction. In contrast, our analysis shows that the share of liquid assets that households invest in risky assets is not affected by wealth changes. Instead, one of the major drivers of household portfolio allocation seems to be inertia: households rebalance only very slowly following inflows and outflows or capital gains and losses.