The Domestic and International Effects of Interstate U.S. Banking

This paper studies the domestic and international effects of the transition to an interstate banking system implemented by the U.S. since the late 1970s in a dynamic, stochastic, general equilibrium model with endogenous producer entry. Interstate banking reduces the degree of local monopoly power of financial intermediaries. We show that the an economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The rest of the world experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to a moderation of firm-level and aggregate output volatility. In turn, trade and financial ties between the two countries in our model allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. The results of the model are consistent with features of the U.S. and international business cycle after the U.S. began its transition to interstate banking.