Financial Market Competition And Economic Growth: The Importance Of How Profits Are Returned

If households have finite lives, the effect of imperfect competition in the financial sector on economic growth depends also on how its profits are returned. The return may be exogenous though fiscal transfers to the young and/or the old or endogenous through dividend payments to a subset of old households that have acquired financial sector equity. Returning financial profits to the old, either exogenously or endogenously, unambiguously reduces growth, but through the two respective mechanisms of consumption‐smoothing and of encouraging ‘unproductive saving’. As the latter is the more powerful, a public pension paid for by taxing financial profits will raise steady‐state growth rate. However, the main results are that if profits are returned to the young, growth will be highest with monopolistic finance, if the elasticity of intertemporal substitution is sufficiently low; and, generally, the number of Nash–Cournot financial firms that maximizes growth is increasing in the value of this parameter.