|The I Theory of Money||1.31 MB|
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.
Many business sectors and households face an unprecedented loss of income in the current COVID recession, triggering financial distress, separations, and bankruptcy. Rather than stimulating demand, government policy’s main aim should be to provide insurance to firms and workers to avoid undue scarring that will hamper a recovery, once the pandemic is past. We develop a corporate finance framework to guide interventions in credit markets to avoid such scarring. We emphasize three main results. First, policy should inject liquidity into small and medium sized firms that are liquidity constrained and for which social costs of bankruptcy are high. Second, large firms for whom solvency is the dominant issue require a more nuanced approach. Debt overhang creates a distortion leading these firms to fire workers, forgo expenditures that maintain enterprise value, and delay filing for a Chapter 11 bankruptcy longer than is socially efficient. Government resources toward reducing the legal and financial costs of bankruptcy are unambiguously beneficial. Policies that reduce funding costs are only socially desirable if the pandemic is expected to be short-lived and if bankruptcy costs are high. Last, transfers necessary to avoid bankruptcy allow borrowers to continue paying their mortgages or credit card bills and ultimately benefit owners of assets such as real estate or credit card receivables. Taxes to fund transfers should be raised from these asset owners.
Link to Webinar Series
Speakers include: Esther Duflo, Janice Eberly, Eric Schmidt, Michael Spence, Erik Hurst, Veronica Guerrieri, Armino Fraga, Raj Chetty, Ken Rogoff, Philip Lane, William Dudley, Gita Gopinath, Larry Summers, Paul Krugman, Joe Stiglitz, Dani Rodrik, Harold James, Hyun Shin, Penny Goldberg, Angus Deaton, Tyler Cowen, Olivier Blanchard, Paul Romer, Nellie Liang, Torsten Slok