I tire of hearing people who had one (or no) class in economics saying “the magic of the marketplace” will lead to the optimal outcome. What teaching finance has made me realize is that information problems are rife in many economic interactions. And one can’t be a student of currency crises without being even more convinced. The paper by Stijn Claessens and Ayhan Kose, “Macroeconomic Implications of Financial Frictions: A Survey” is a must-read for those who want to keep up with the literature. It has this fantastic schematic:
Source: Claessens and Kose (2017).
From the conclusion:
…In particular, extensive evidence documents how the state of borrowers’ balance sheets affects their access to external finance. Demand side imperfections in financial markets have been shown to lead to an amplification of shocks (monetary, real and financial) because changes in the net worth of borrowers affect their access to finance and, therefore, to consumption, investment and output. Empirical studies confirm that these imperfections tend to affect small firms and households particularly strongly, especially during periods of financial stress. Although most findings support the roles played by financial imperfections, there is nevertheless an ongoing debate about the quantitative importance of the financial accelerator.
The GFC has shifted attention to the critical role played by amplification channels operating through the supply side of finance. Earlier theoretical work on the bank lending channel analysed the possible general equilibrium effects arising from the special role of banks in financial intermediation. Empirical studies documented how the dependence of some firms on bank financing influences the transmission of monetary policy to the real economy. Since the GFC, there has been a broader recognition that the supply side of finance (beyond the specific role played by banks for some firms) can be a source of shocks, amplification and propagation.
I think those who are analyzing the macro/business cycle implications of the enormous give-away to financial institutions and already-cash rich corporations that is the Tax Cuts and Jobs Act would do well to contemplate what a non-neoclassical approach implies for the near future. (Does one really think that full expensing of short term capital expenditures will matter that much for investment? See this post for discussion.)
See also this post on macro/finance linkages.