The I Theory of Money
This paper provides a theory of money, whose value depends on the functioning of the intermediary sector, and a unified framework for analyzing the interaction between price and financial stability. Households that happen to be productive in this period finance their capital purchases with credit from intermediaries and from their own savings. Less productive household save by holding deposits with intermediaries (inside money) or outside money. Intermediation involves risk-taking, and intermediaries' ability to lend is compromised when they suffer losses. After an adverse productivity shock, credit and inside money shrink, and the value of (outside) money increases, causing deflation that hurts borrowers even further. An accommodating monetary policy in downturns can mitigate these destabilizing adverse feedback effects. Lowering short-term interest rates increases the value of long-term bonds, recapitalizes the intermediaries by redistributes wealth. While this policy helps the economy ex-post, ex-ante it can lead to excessive risk-taking by the intermediary sector.
|Date of creation:||2012|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
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