Procyclical Finance: The Money View

75 Pages Posted: 25 Oct 2017 Last revised: 30 Nov 2017

Ye Li

Ohio State University

Date Written: November 19, 2017

Abstract

Banks are important because firms hold their debt ("inside money") as liquidity buffer. Banking crises are costly because the contraction of inside money supply compromises firms' liquidity management and hurts investment. By highlighting the interaction between banks and firms in the money market, this paper offers a theory of procyclical inside money creation and the resulting instability. It sheds light on the cyclicality of bank leverage, and how it affects the frequency and duration of banking crises. Introducing outside money (government debt) to alleviate liquidity shortage can be counterproductive, because its competition with inside
money destabilizes the banking sector.

Keywords: Inside money, liquidity management, procyclical leverage, government debt, slow recovery, intertemporal feedback

JEL Classification: E02, E22, E32, E41, E43, E44, E51, E58, E61, E62, G01, G12, G18, G20, G30

Suggested Citation

Li, Ye, Procyclical Finance: The Money View (November 19, 2017). Fisher College of Business Working Paper No. 2017-03-24; Columbia Business School Research Paper No. 17-106; Charles A. Dice Center Working Paper No. 2017-24. Available at SSRN: https://ssrn.com/abstract=3057997 or http://dx.doi.org/10.2139/ssrn.3057997

Ye Li (Contact Author)

Ohio State University ( email )

Fisher Hall 836, 2100 Neil Ave
Columbus, OH 43210
United States

HOME PAGE: http://yeli-macrofinance.com

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