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Financing Development: The Role of Information Costs

  • Jeremy Greenwood
  • Juan M. Sanchez
  • Cheng Wang

How does technological progress in financial intermediation affect the economy? To address this question a costly-state verification framework is embedded into a standard growth model. In particular, financial intermediaries can invest resources to monitor the returns earned by firms. The inability to monitor perfectly leads to firms earning rents. Undeserving firms are financed, while deserving ones are under funded. A more efficient monitoring technology squeezes the rents earned by firms. With technological advance in the financial sector, the economy moves continuously from a credit-rationing equilibrium to a perfectly efficient competitive equilibrium. A numerical example suggests that finance is important for growth.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13104.

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Date of creation: May 2007
Date of revision:
Publication status: published as Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2010. "Financing Development: The Role of Information Costs," American Economic Review, American Economic Association, vol. 100(4), pages 1875-91, September.
Handle: RePEc:nbr:nberwo:13104
Note: EFG CF
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