Financial Intermediation and Macroeconomic Analysis

I ssues relating to fi nancial stability have always been part of the macroeconomics curriculum, but they have often been presented as mainly of historical interest, or primarily of relevance to emerging markets. However, the recent fi nancial crisis has made it plain that even in economies like the United States, signifi cant disruptions of fi nancial intermediation remain a possibility. Understanding such phenomena and the possible policy responses requires the use of a macroeconomic framework in which fi nancial intermediation matters for the allocation of resources. In this paper, I fi rst discuss why neither standard macroeconomic models that abstract from fi nancial intermediation nor traditional models of the “bank lending channel” are adequate as a basis for understanding the recent crisis. I argue that instead we need models in which intermediation plays a crucial role, but in which intermediation is modeled in a way that better conforms to current institutional realities. In particular, we need models that recognize that a market-based fi nancial system—one in which intermediaries fund themselves by selling securities in competitive markets, rather than collecting deposits subject to reserve requirements—is not the same as a frictionless system. I then sketch the basic elements of an approach that allows fi nancial intermediation and credit frictions to be integrated into macroeconomic analysis in a straightforward way. I show how the model can be used to analyze the macroeconomic consequences of the recent fi nancial crisis and conclude with a discussion of some implications of the model for the conduct of monetary policy. Financial Intermediation and Macroeconomic Analysis