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Should Wall-Street be occupied ? an overlooked price externality of financial intermediation

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  • Eden, Maya

Abstract

Does an unregulated financial system absorb too many productive inputs? This paper studies this question in the context of a dynamic model with heterogeneous producers. In the absence of a financial system, the only way to purchase inputs is using internal funds. Producers are subject to idiosyncratic productivity shocks, and will decide to produce only if their productivity is high enough. Otherwise, they will hold money. A financial intermediation technology allows producers to purchase inputs in excess of their internal funds, by borrowing from unproductive agents. However, intermediation requires the use of costly monitoring services. In equilibrium, intermediation increases the money in circulation and raises nominal prices, thereby reducing the value of internal funds and making producers increasingly reliant on costly monitoring services. For this reason, society is better off when intermediation is restricted.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 6059.

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Date of creation: 01 May 2012
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Handle: RePEc:wbk:wbrwps:6059

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Keywords: Economic Theory&Research; Access to Finance; Fiscal&Monetary Policy; Islamic Finance; Markets and Market Access;

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  1. Rajnish Mehra & Facundo Piguillem & Edward C. Prescott, 2008. "Costly Financial Intermediation in Neoclassical Growth Theory," NBER Working Papers 14351, National Bureau of Economic Research, Inc.
  2. Andrew B. Abel, 1985. "Dynamic Behavior of Capital Accumulation in a Cash-in-Advance Model," NBER Working Papers 1549, National Bureau of Economic Research, Inc.
  3. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
  4. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  5. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  6. António Antunes & Tiago Cavalcanti & Anne Villamil, 2013. "Costly Intermediation And Consumption Smoothing," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 459-472, 01.
  7. Vincent Glode & Richard C. Green & Richard Lowery, 2012. "Financial Expertise as an Arms Race," Journal of Finance, American Finance Association, vol. 67(5), pages 1723-1759, October.
  8. Stockman, Alan C., 1981. "Anticipated inflation and the capital stock in a cash in-advance economy," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 387-393.
  9. Enrico Berkes & Ugo Panizza & Jean-Louis Arcand, 2012. "Too Much Finance?," IMF Working Papers 12/161, International Monetary Fund.
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Cited by:
  1. Eden, Maya, 2013. "International liquidity rents," Policy Research Working Paper Series 6462, The World Bank.

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