Research

Working Papers
Brunnermeier, Markus K, and Yuliy Sannikov. “The I Theory of Money”. Working Papers: n. pag. Print.Abstract

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.

The I Theory of Money
Brunnermeier, Markus K., Sebastian Merkel, and Yuliy Sannikov. “A Safe Asset Perspective for an Integrated Policy Framework”. Working Papers. Print.Abstract
Borrowing from Brunnermeier and Sannikov (2016, 2019) this policy paper sketches a policy framework for emerging market economies by mapping out the roles and interactions of  monetary policy, macroprudential policies, foreign exchange interventions, and capital controls. Safe assets are central in a world in which financial frictions, distribution of risk, and risk premia are important elements. The paper also proposes a global safe asset for a more self-stabilizing global financial architecture.
safeassetinternational.pdf
Brunnermeier, Markus K., Sebastian Merkel, and Yuliy Sannikov. “The Fiscal Theory of the Price Level with a Bubble”. Working Papers. Print.Abstract
This paper incorporates a bubble term in the standard FTPL equation to explain why countries with persistently negative primary surpluses can have a positively valued currency and low inflation. It also provides an example with closed-form solutions in which idiosyncratic risk on capital returns depresses the interest rate on government bonds below the economy's growth rate.
04a_ftpl_bubble_paper.pdf
Brunnermeier, Markus K., Rohit Lamba, and Carlos Segura-Rodriguez. “Inverse Selection”. Working Papers. Print.Abstract
Big data, machine learning and AI inverts adverse selection problems. It allows insurers to infer statistical information and thereby reverses information advantage from the insuree to the insurer. In a setting with two-dimensional type space whose correlation can be inferred with big data we derive three results: First, a novel tradeoff between a belief gap and price discrimination emerges. The insurer tries to protect its statistical information by offering only a few screening contracts. Second, we show that forcing the insurance company to reveal its statistical information can be welfare improving. Third, we show in a setting with naive agents that do not perfectly infer statistical information from the price of offered contracts, price discrimination significantly boosts insurer's profits. We also discuss the significance our analysis through three stylized facts: the rise of data brokers, the importance of consumer activism and regulatory forbearance, and merits of a public data repository. 
inverse_selection.pdf inverse_selection_slides_nber.pdf
The Digitalization of Money
Brunnermeier, Markus K., Harold James, and Jean-Pierre Landau. “The Digitalization of Money”. Working Papers. Print.Abstract
The ongoing digital revolution may lead to a radical departure from the traditional model of monetary exchange. We may see an unbundling of the separate roles of money, creating fiercer competition among specialized currencies. On the other hand, digital currencies associated with large platform ecosystems may lead to a re-bundling of money in which payment services are packaged with an array of data services, encouraging differentiation but discouraging interoperability between platforms. Digital currencies may also cause an upheaval of the international monetary system: countries that are socially or digitally integrated with their neighbors may face digital dollarization, and the prevalence of systemically important platforms could lead to the emergence of digital currency areas that transcend national borders. Central bank digital currency (CBDC) ensures that public money remains a relevant unit of account. 
02c_digitalmoney.pdf
Blickle, Kristian, Markus K. Brunnermeier, and Stephan Luck. “Micro-Evidence From a System-Wide Financial Meltdown: The German Crisis of 1931”. (Working Papers). Web. Publisher's VersionAbstract
This paper studies  a major financial panic, the run on the German banking system in 1931, to distinguish between banking theories that view depositors as demanders of liquidity and those that view them as providers of discipline.
Our empirical approach exploits the fact that the German Crisis of 1931 was system-wide with cross-sectional variation in deposit flows as well as bank distress and took place in absence of a deposit insurance scheme.
We find that interbank deposit flows predict subsequent bank distress early on. In contrast, wholesale depositors are more likely to withdraw from distressed banks at later stages of the run and only after the interbank market has started to collapse. Retail deposits are---despite the absence of deposit insurance---largely stable. Our findings emphasize the heterogeneity in depositor roles, with discipline being best provided through the interbank market.
bankrun_germany1931_slides.pdf
Abadi, Joseph, and Markus K. Brunnermeier. “Blockchain Economics”. Working Papers: n. pag. Print.Abstract

When is record-keeping better arranged through a blockchain than through a traditional centralized intermediary? The ideal qualities of any record-keeping system are (i) correctness, (ii) decentralization, and (iii) cost efficiency. We point out a \textit{blockchain trilemma}: no ledger can satisfy all three properties simultaneously. A centralized record-keeper extracts rents due to its monopoly on the ledger. Its franchise value dynamically incentivizes correct reporting. Blockchains drive down rents by allowing for free entry of  record-keepers and portability of information to competing ``forks.'' Blockchains must therefore provide static incentives for correctness through computationally expensive proof-of-work algorithms and permit record-keepers to roll back history in order to undo fraudulent reports. While blockchains can keep track of ownership transfers, enforcement of possession rights is often better complemented by centralized record-keeping.

BlockchainEconomics_paper_v7a.pdf BlockchainEconomics_slides_cesc.pdf
Brunnermeier, Markus K., Pierre-Olivier Gourinchas, and Oleg Itskhoki. “Consumption-led Growth”. (Working Papers). Web. Publisher's Version growth_ca_slides_bdf.pdf
Brunnermeier, Markus K., and Ricardo Reis. “A Crash Course on the Euro Crisis”. (Working Papers). Print.Abstract

The financial crises of the last twenty years brought new economic concepts into classrooms discussions. This article introduces undergraduate students and teachers to seven of these models: (i) misallocation of capital inflows, (ii) modern and shadow banks, (iii) strategic complementarities and amplification, (iv) debt contracts and the distinction between solvency and liquidity, (v) the diabolic loop, (vi) regional flights to safety, and (vii) unconventional monetary policy. We apply each of them to provide a full account of the euro crisis of 2010-12.

19-crashcourse.pdf brunnermeierreis-crashcourse-sec2.pptx brunnermeierreis-crashcourse-sec3.pptx brunnermeierreis-crashcourse-sec4.pptx brunnermeierreis-crashcourse-sec5.pptx brunnermeierreis-crashcourse-sec6.pptx brunnermeierreis-crashcourse-sec7.pptx brunnermeierreis-crashcourse-sec8.pptx
Arora, Sanjeev, et al.Computational Complexity and Information Asymmetry in Financial Products”. Working Papers. Print.Abstract

Traditional economics argues that financial derivatives, like CDOs and CDSs, ameliorate the negative costs imposed by asymmetric information. This is because securitization via derivatives allows the informed party to find buyers for less information-sensitive part of the cash flow stream of an asset (e.g., a mortgage) and retain the remainder. In this paper we show that this viewpoint may need to be revised once computational complexity is brought into the picture. Using methods from theoretical computer science this paper shows that derivatives can actually amplify the costs of asymmetric information instead of reducing them. Note that computational complexity is only a small departure from full rationality since even highly sophisticated investors are boundedly rational due to a lack of requisite computational resources.

Complexity and Derivatives.pdf
In Preparation
Brunnermeier, Markus K, and Valentin Haddad. “Safe Assets”. (In Preparation). Print.
Submitted
Brunnermeier, Markus K., Michael Sockin, and Wei Xiong. “China's Model of Managing its Financial System”. China's Model of Managing its Financial System Submitted: n. pag. Print.Abstract

China's economic model involves active government intervention in financial markets. We develop a theoretical framework that anchors government intervention on a mission to prevent market breakdown and volatility explosion caused by the reluctance of short-term investors to trade against noise traders. In the presence of information frictions the
government can alter market dynamics by making noise in its intervention program an additional factor driving asset prices, and can divert investor attention toward acquiring information about this noise factor rather than fundamentals (as a result of complementarity in investors' information acquisition). Through this latter channel, the widely-adopted objective of government intervention to reduce asset price volatility may exacerbate,
rather than improve, information efficiency of asset prices.

ChinaFinancialSystem10e.pdf
Brunnermeier, Markus K., and Yann Koby. “The Reversal Interest Rate”. (Submitted). Print.Abstract

The reversal interest rate is the rate at which accommodative monetary policy reverses and becomes contractionary for lending. Its determinants are (i) banks' fixed-income holdings, (ii) the strictness of capital constraints, (iii) the degree of pass-through to deposit rates, and (iv) the initial capitalization of banks. Quantitative easing increases the reversal interest rate and should only be employed after interest rate cuts are exhausted. Over time the reversal interest rate creeps up since asset revaluation fades out as fixed-income holdings mature while net interest income stays low. We calibrate a New Keynesian model that embeds our banking frictions.

 

 

26d_rir_slides.pdf 25b_reversalrate.pdf
Forthcoming
Brunnermeier, Markus K.Feedbacks: Financial Markets and Economic Activity”. American Economic Review (Forthcoming). Print.Abstract
Is credit expansion a sign of desirable financial deepening or the prelude to an inevitable bust? We study this question in modern US data using a structural VAR model of 10 monthly-frequency variables, identified by heteroskedasticity. Negative reduced-form responses of output to credit growth are caused by endogenous monetary policy response to credit expansion shocks. On average, credit and output growth remain positively associated. “Financial stress” shocks to credit spreads cause declines in output and credit levels. Neither credit aggregates nor spreads provide much advance warning of the 2008-9 crisis, but spreads improve within-crisis forecasts.
04brunnermeierdariussaskisims.pdf
Brunnermeier, Markus K., and Arvind Krishnamurthy. “Corporate Debt Overhang and Credit Policy”. Brooking Papers of Economic Activity (Forthcoming). Web. Publisher's VersionAbstract

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.

brunnermeier_and_krishnamurthy_brookings_paper_conference_draft.pdf
2020
Brunnermeier, Markus K., and Arvind Krishnamurthy. “The Macroeconomics of Corporate Debt”. Review of Corporate Financial Studies 9 (2020): , 9, 656-665. Web. Publisher's VersionAbstract
The 2020 COVID-19 crisis can spur research on firms’ corporate finance decisions and their macroeconomic implications, similar to the wave of important research on banking and household finance triggered by the 2008 financial crisis. What are the relevant corporate finance mechanisms in this crisis? Modeling dynamics and timing considerations are likely important, as is integrating corporate financing considerations into modern quantifiable macroeconomics models. Recent empirical work, including articles in this special issue, on the drag from debt in the COVID-19 crisis provides a first glimpse into the new research agenda. 
brunnermeierkrishnamurthy2020_rcfs.pdf
Brunnermeier, Markus K., Simon Rother, and Isabel Schnabel. “Asset Price Bubbles and Systemic Risk”. Review of Financial Studies 33 (2020): , 33, 4272-4317. Web. Publisher's VersionAbstract
We analyze the relationship between asset price bubbles and systemic risk, using bank-level data covering almost thirty years. Systemic risk of banks rises already during a bubble's build-up phase, and even more so during its bust. The increase differs strongly across banks and bubble episodes. It depends on bank characteristics (especially bank size) and bubble characteristics, and it can become very large: In a median real estate bust, systemic risk increases by almost 70~percent of the median for banks with unfavorable characteristics. These results emphasize the importance of bank-level factors for the build-up of financial fragility during bubble episodes.
Bubbles_SystemicRisk.pdf
Brunnermeier, Markus K., Gang Dong, and Darius Palia. “Banks' Non-Interest Income and Systemic Risk”. Review of Corporate Financial Studies 92 (2020): , 9, 2, 229-255. Web. Publisher's VersionAbstract

This paper finds non-interest income to be positively correlated with total systemic risk for a large sample of U.S. banks.  Decomposing total systemic risk into three components, we find that non-interest income has a positive relationship with a bank’s tail risk, a positive relationship with a bank’s interconnectedness risk, and an insignificant or positive relationship with a bank’s exposure to macroeconomic and finance factors. These results are generally robust to endogenizing for non-interest income and for trading and other non-interest income activities.

Banks Non-Interest Income and Systemic Risk.pdf
2019
Brunnermeier, Markus K., and Lunyang Huang. “A Global Safe Asset From and For Emerging Economies”. Monetary Policy and Financial Stability: Transmission Mechanisms and Policy Implications. Santiago de Chile: Central Bank of Chile, 2019. 111-167. Print.Abstract
This paper examines international capital flows induced by flight-to-safety and proposes a new global safe asset. In the model domestic investors have to co-invest in a safe asset along with their physical capital. At times of crisis, investors replace the initially safe domestic government bonds with safe US Treasuries and fire-sell part of their capital. The reduction in physical capital lowers GDP and tax revenue, leading to increased default risk justifying the loss of the government bond's safe-asset status. We compare two ways to mitigate this self-fulfilling scenario. In the ``buffer approach” international reserve holding reduces the severity of a crisis. In the ``rechannelling approach'' flight-to-safety capital flows are rechannelled from international cross-border flows to flows across two EME asset classes. The two asset classes are the senior and junior bond of tranched portfolio of EME sovereign bonds.
globalsafeasset_34r.pdf 05d_globalsafeasset_slides.pdf
Brunnermeier, Markus K., and Dirk Niepelt. “On the Equivalence of Private and Public Money”. Journal of Monetary Economics 106 (2019): , 106, 27-41. Web. Publisher's VersionAbstract
We develop a generic model of money and liquidity that identifies sources of liquidity bubbles and seignorage rents. We provide sufficient conditions under which a swap of monies leaves the equilibrium allocation and price system unchanged. We apply the equivalence result to the ``Chicago Plan,'' cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). In particular, we show why CBDC need not undermine financial stability.
working_paper.pdf
Brunnermeier, Markus K., and Patrick Cheridito. “Measuring and Allocating Systemic Risk”. Risks 746 (2019). Web. Publisher's VersionAbstract

This paper develops a framework for measuring, allocating and managing systemic risk. SystRisk, our measure of total systemic risk captures the a priori cost to society for providing tail-risk insurance to the financial system. Our allocation principle distributes the total systemic risk among individual institutions according to their size-shifted marginal contributions. To describe economic shocks and systemic feedback effects we propose a reduced form stochastic model that can be calibrated to historical data. We also discuss systemic risk limits, systemic risk charges and a cap and trade system for systemic risk.

systrisk2019.pdf
2018
Brunnermeier, Markus K., Rush Doshi, and Harold James. “Beijings' Bismarckian Ghosts: How Great Powers Compete Economically”. The Washington Quarterly Fall (2018). Print. china_germany_rise.pdf
2017
Brunnermeier, Markus K., Michael Sockin, and Wei Xiong. “China's Gradual Economics Approach and Financial Markets”. American Economic Review Papers and Proceedings 107.5 (2017). Print.Abstract

China’s gradualistic approach allowed the government to learn how the economy reacts to small policy changes, and to adjust its reforms before implementing them in full. With fully developed financial markets, however, private actors’ may front-run future policy changes making it impossible for the implement policies gradually. With financial markets the government faces a time-inconsistency problem. The government would like to commit to a gradualistic approach, but after it observes the economy’s quick reaction, it has no incentive to implement its policies in small steps.

China's Gradualistic Economic Approach.pdf
Brunnermeier, Markus K., et al.ESBies: Safety in the Tranches”. Economic Policy (2017). Print.Abstract

The euro crisis was fueled by the diabolic loop between sovereign risk and bank risk, coupled with cross-border flight-to-safety capital flows. European Safe Bonds (ESBies), a union-wide safe asset without joint liability, would help to resolve these problems. We make three contributions. First, numerical simulations show that ESBies would be at least as safe as German bunds and approximately double the supply of euro safe assets when protected by a 30%-thick junior tranche. Second, a model shows how, when and why the two features of ESBies---diversification and seniority---can weaken the diabolic loop and its diffusion across countries. Third, we propose a step-by-step guide on how to create ESBies, starting with limited issuance by public or private-sector entities.

10e_european-safe-bonds_ep.pdf
Macro, Money and Finance: A Continuous-Time Approach
Brunnermeier, Markus K., and Yuliy Sannikov. “Macro, Money and Finance: A Continuous-Time Approach”. Handbook of Macroeconomics. North-Holland, 2017. 1497-1546. Print.Abstract

This paper puts forward a manual for how to set up and solve a continuous time model that allows to analyze endogenous (1) level and risk dynamics. The latter includes (2) tail risk and crisis probability as well as (3) the Volatility Paradox. Concepts such as (4) illiquidity and liquidity mismatch, (5) endogenous leverage, (6) the Paradox of Prudence, (7) undercapitalized sectors (8) time-varying risk premia, and (9) the external funding premium are part of the analysis. Financial frictions also give rise to an endogenous (10) value of money.

_macrohandbook_brusan.pdf

Pages