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Financial Intermediation and Aggregate Demand: A Sufficient Statistics Approach

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Abstract

We provide a unified framework to study how the financial sector affects the transmission of macroeconomic policies, such as monetary and fiscal policies, and asset purchase programs. Our framework nests models of financial intermediation with various microfoundations and allows for rich household heterogeneity. The financial sector supplies liquidity by issuing liquid assets to finance illiquid capital. The elasticities of liquidity supply with respect to returns are sufficient statistics that summarize how the financial sector determines responses to policy through asset markets. This asset market channel has a strong effect on output when liquidity supply is inelastic. We apply our approach to study the relative effectiveness of policies targeting the financial sector versus households. In commonly used setups, aggregate output responses differ by orders of magnitude due to implicit assumptions about the elasticities. Our estimates of the liquidity supply elasticities for the U.S. economy imply a modest effect through the asset markets and a stronger effect of targeting households.

Suggested Citation

  • Yu-Ting Chiang & Piotr Żoch, 2022. "Financial Intermediation and Aggregate Demand: A Sufficient Statistics Approach," Working Papers 2022-038, Federal Reserve Bank of St. Louis, revised 26 Jul 2023.
    • Handle: RePEc:fip:fedlwp:95204
    DOI: 10.20955/wp.2022.038
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    More about this item

    Keywords

    financial frictions; liquidity; monetary policy; fiscal policy; Heterogeneous-agent New Keynesian (HANK) model;
    All these keywords.

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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