This article surveys the macroeconomic implications of financial frictions. Financial frictions lead to persistence and when combined with illiquidity to non-linear amplification effects. Risk is endogenous and liquidity spirals cause financial instability. Increasing margins further restrict leverage and exacerbate downturns. A demand for liquid assets and a role for money emerges. The market outcome is generically not even constrained efficient and the issuance of government debt can lead to a Pareto improvement. While financial institutions can mitigate frictions, they introduce additional fragility and through their erratic money creation harm price stability.

We construct a new systemic risk measure that quantifies vulnerability to firesale spillovers using detailed regulatory balance sheet data for U.S. commercial banks and repo market data for broker-dealers. Even for moderate shocks in normal times, fire-sale externalities can be substantial. For commercial banks, a 1 percent exogenous shock to assets in 2013-Q1 produces fire sale externalities equal to 21 percent of system capital. For broker-dealers, a 1 percent shock to assets in August 2013 generates spillover losses equivalent to almost 60 percent of system capital. Externalities during the last financial crisis are between two and three times larger. Our systemic risk measure reaches a peak in the fall of 2007 but shows a notable increase starting in 2004, ahead of many other systemic risk indicators. Although the largest banks and broker-dealers produce -and are victims of -most of the externalities, leverage and linkages of financial institutions also play important roles.

We construct a new systemic risk measure that quantifies vulnerability to firesale spillovers using detailed regulatory balance sheet data for U.S. commercial banks and repo market data for broker-dealers. Even for moderate shocks in normal times, fire-sale externalities can be substantial. For commercial banks, a 1 percent exogenous shock to assets in 2013-Q1 produces fire sale externalities equal to 21 percent of system capital. For broker-dealers, a 1 percent shock to assets in August 2013 generates spillover losses equivalent to almost 60 percent of system capital. Externalities during the last financial crisis are between two and three times larger. Our systemic risk measure reaches a peak in the fall of 2007 but shows a notable increase starting in 2004, ahead of many other systemic risk indicators. Although the largest banks and broker-dealers produce -and are victims of -most of the externalities, leverage and linkages of financial institutions also play important roles.

This article surveys the macroeconomic implications of financial frictions. Financial frictions lead to persistence and when combined with illiquidity to nonlinear amplification effects. Risk is endogenous and liquidity spirals cause financial instability. Increasing margins further restrict leverage and exacerbate downturns.A demand for liquid assets and a role for money emerges. The market outcome is generically not even constrained efficient and the issuance of government debt can lead to a Pareto improvement. While financial institutions can mitigate frictions, they introduce additional fragility and through their erratic money creation harm price stability.

Why does the market discipline that financial intermediaries face seem too weak during booms and too strong during crises? This paper shows in a general equilibrium setting that rollover risk as a disciplining device is effective only if all intermediaries face purely idiosyncratic risk. However, if assets are correlated, a two-sided inefficiency arises: Good aggregate states have intermediaries taking excessive risks, while bad aggregate states suffer from costly fire sales. The driving force behind this inefficiency is an amplifying feedback loop between asset values and market discipline. In equilibrium, financial intermediaries inefficiently amplify both positive and negative aggregate shocks.