Can Financial Intermediation Induce Economic Fluctuations?
AbstractWe construct a model to show that active financial intermediation can induce economic fluctuations. We embed a financial sector in a simple overlapping generation model with a single stock of capital. Individuals are risk averse agents that face idiosyncratic risks in their business activities: Due to limited liability, agents have incentives to invest in a technology that produces high output with a smaller probability. Financial intermediaries (FIs) are risk neutral. We distinguish two scenarios. The first scenario is one with active financial intermediation: the FIs lends only on the conditions that borrowers accept restrictions on their investments. In the second scenario, financial intermediation is passive, in that the FIs lend without monitoring the activities of the borrowers. For a given loan size, the investment level under active financial intermediation is shown to be smaller than under passive financial intermediation. This fact alone creates, in the first scenario, an income effect that may generate fluctuations in investment. (This effect is absent under passive financial intermediation, and, as a result, in our model there are no fluctuations under passive financial intermediation.) Thus business cycles and possibly chaotic dynamics can be, under certain conditions, generated by active intermediation. On étudie un modèle qui montre que l'intermédiation active des institutions financières peut générer les fluctuations. Il s'agit d'un modèle aux générations imbriquées avec un stock de capital. Les individus sont riscophobes, tandis que les institutions financières (I.F.) ne le sont pas. On considère deux cas. Dans le premier cas, les I.F. sont actives: elles prêtent de l'argent sous la condition que les emprunteurs acceptent des restrictions sur leurs choix de projets d'investissement. Dans le deuxième cas, les I.F. sont passives. Nous démontrons que si les I.F. sont actives, les conditions de prêts peuvent créer un effet de richesse qui peut générer les fluctuations du taux d'investissement, et du P.I.B.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by CIRANO in its series CIRANO Working Papers with number 2000s-51.
Date of creation: 01 Nov 2000
Date of revision:
Contact details of provider:
Postal: 2020 rue University, 25e étage, Montréal, Quéc, H3A 2A5
Phone: (514) 985-4000
Fax: (514) 985-4039
Web page: http://www.cirano.qc.ca/
More information through EDIRC
Financial intermediation; endogenous fluctuations; Intermédiation financière; fluctuations endogènes;
Find related papers by JEL classification:
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- G2 - Financial Economics - - Financial Institutions and Services
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Stacey L. Schreft & Bruce D. Smith, 1994.
"Money, banking, and capital formation,"
94-05, Federal Reserve Bank of Richmond.
- Roger E. A. Farmer, 1999. "Macroeconomics of Self-fulfilling Prophecies, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062038, June.
- Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, vol. 25(3), pages 380-396, December.
- Smith, Bruce D, 1991.
"Interest on Reserves and Sunspot Equilibria: Friedman's Proposal Reconsidered,"
Review of Economic Studies,
Wiley Blackwell, vol. 58(1), pages 93-105, January.
- Smith, B.D., 1988. "Interest On Reserves And Sunspot Equilibria: Friedman'S Proposal Reconsidered," RCER Working Papers 119, University of Rochester - Center for Economic Research (RCER).
- Franklin Allen & Douglas Gale, 1996.
"Financial Markets, Intermediaries and Intertemporal Smoothing,"
Center for Financial Institutions Working Papers
96-33, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Allen, Franklin & Gale, Douglas, 1997. "Financial Markets, Intermediaries, and Intertemporal Smoothing," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 523-46, June.
- Franklin Allen & Douglas Gale, 1995. "Financial markets, intermediaries, and intertemporal smoothing," Working Papers 95-4, Federal Reserve Bank of Philadelphia.
- Franklin Allen & Douglas Gale, 1995. "Financial Markets, Intermediaries, and Intertemporal Smoothing," Center for Financial Institutions Working Papers 95-02, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
- Boldrin, Michele & Woodford, Michael, 1990.
"Equilibrium models displaying endogenous fluctuations and chaos : A survey,"
Journal of Monetary Economics,
Elsevier, vol. 25(2), pages 189-222, March.
- Michele Boldrin & Michael Woodford, 1988. "Equilibruim Models Displaying Endogenous Fluctuations and Chaos: A Survey," UCLA Economics Working Papers 530, UCLA Department of Economics.
- Douglas W. Diamond & Philip H. Dybvig, 2000.
"Bank runs, deposit insurance, and liquidity,"
Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
- de Meza, David & Webb, David, 1999. "Wealth, Enterprise and Credit Policy," Economic Journal, Royal Economic Society, vol. 109(455), pages 153-63, April.
- Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
- Grandmont, Jean-Michel, 1985. "On Endogenous Competitive Business Cycles," Econometrica, Econometric Society, vol. 53(5), pages 995-1045, September.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Webmaster).
If references are entirely missing, you can add them using this form.