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Macroeconomic Fragility Effects of Financial Innovation: Behavioral and Decentralized Finance and Artificial Intelligence

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  • Dimitri B. Papadimitriou

Abstract

There seems to be a building consensus of global uncertainty and instability. This can be observed not only from surveys, the media, and country reports, but in the recent speeches by members of the Federal Reserve Board of Governors. The Fed speeches focus on financial stability, not the usual price stability, but that of the financial system. Not surprising, given the unstable conditions of the US economy emanating from the geopolitical conflicts in the Middle East and elsewhere, is the excessive volatility and overvaluation of the equity markets and the public sector's erratic fiscal and trade policy stance. Reports show that equity funds loaded with AI investments--what we may call "emotional investments"--are now looking to unload them in the financial market, adding more fuel to market volatility that may cause a financial crisis, reminiscent of previous crises. The solution may lie in the implementation of a totally new economic regime in answer to recurring macroeconomic fragility. This paper considers the current conditions of macroeconomic fragility. It explores the challenges and risks to financial system stability that emerge from innovation-developed and increasingly decentralized finance--including the effects of cryptoassets, tokenization of digital assets, and artificial intelligence.

Suggested Citation

  • Dimitri B. Papadimitriou, 2026. "Macroeconomic Fragility Effects of Financial Innovation: Behavioral and Decentralized Finance and Artificial Intelligence," Economics Working Paper Archive wp_1114, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_1114
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    References listed on IDEAS

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    1. Matteo Aquilina & Giulio Cornelli & Jon Frost & Leonardo Gambacorta, 2025. "Cryptocurrencies and decentralised finance: functions and financial stability implications," BIS Papers, Bank for International Settlements, number 156.
    2. Vincent Barnett, 2015. "Keynes and the Psychology of Economic Behavior: From Stout and Sully to The General Theory," History of Political Economy, Duke University Press, vol. 47(2), pages 307-333, June.
    3. Sheila C. Dow, 2011. "Cognition, market sentiment and financial instability," Cambridge Journal of Economics, Cambridge Political Economy Society, vol. 35(2), pages 233-249.
    4. Leonardo Burlamaqui, 2025. "Creative Destruction Meets Financial Instability: Toward a New Synthesis," Economics Working Paper Archive wp_1098, Levy Economics Institute.
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    Keywords

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    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Systems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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