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Financing development: the role of information costs

  • Jeremy Greenwood
  • Juan M. Sánchez
  • Cheng Wang

To address how technological progress in financial intermediation affects the economy, a costly state verification framework is embedded into the standard growth model. The framework has two novel ingredients. First, firms differ in the risk/return combinations that they offer. Second, the efficacy of monitoring depends upon the amount of resources invested in the activity. A financial theory of firm size results. Undeserving firms are over financed, deserving ones under funded. Technological advance in intermediation leads to more capital accumulation and a redirection of funds away from unproductive firms toward productive ones. With continued progress, the economy approaches its first-best equilibrium.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2010-024.

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Date of creation: 2010
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Handle: RePEc:fip:fedlwp:2010-024
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