Macroeconomic implications of financial imperfections: a survey

BIS Working Papers No 677
November 2017



Over the last decade, recognition has grown that developments in the financial sector can have a significant impact on the real economy, not just the other way around. However, our understanding of these interactions remains limited, particularly regarding how they operate across national borders.


This paper reviews research on links between the financial sector, which suffers from imperfections, and the real economy. It focuses on two major channels through which financial market imperfections can affect the real economy. On the demand (borrowing) side, changes in borrowers' balance sheets can affect access to finance and thereby amplify and spread economic and financial shocks. On the supply (lending) side, changes in banks' and other lenders' balance sheets and the state of financial markets can affect the supply of credit, liquidity and asset prices, and thereby economic outcomes.

The paper emphasises the global dimensions of these dynamics and attempts to identify gaps in the literature.


The paper finds that there has been substantial progress in identifying demand-side channels, with many economic models now featuring amplification mechanisms. The stylised features of business and financial cycles and their links are now better documented. However, there has been less headway in modelling supply-side channels.

The paper identifies four promising areas for additional work. First, to develop richer models of demand- and supply-side channels, especially the latter. Second, to improve data about the behaviour of firms and households to identify what drives linkages between business and financial cycles. Third, to better analyse the cross-border transmission of financial and real shocks. Fourth, to incorporate the findings into the design of policy, including macroprudential and monetary policy.



This paper surveys the theoretical and empirical literature on the macroeconomic implications of financial imperfections. It focuses on two major channels through which financial imperfections can affect macroeconomic outcomes. The first channel, which operates through the demand side of finance and is captured by financial accelerator-type mechanisms, describes how changes in borrowers' balance sheets can affect their access to finance and thereby amplify and propagate economic and financial shocks. The second channel, which is associated with the supply side of finance, emphasises the implications of changes in financial intermediaries' balance sheets for the supply of credit, liquidity and asset prices, and, consequently, for macroeconomic outcomes. These channels have been shown to be important in explaining the linkages between the real economy and the financial sector. That said, many questions remain.

JEL classification: D53, E21, E32, E44, E51, F36, F44, F65, G01, G10, G12, G14, G15, G21

Keywords: asset prices, balance sheets, credit, financial accelerator, financial intermediation, financial linkages, international linkages, leverage, liquidity, macrofinancial linkages, output, real-financial linkages