Working Paper: NBER ID: w13104
Authors: Jeremy Greenwood; Juan M. Sanchez; Cheng Wang
Abstract: 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.
Keywords: financial intermediation; economic growth; information costs
JEL Codes: E44; O11; O16; O43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Technological progress in financial intermediation (O16) | Economic growth (O49) |
| Reductions in the cost of information processing (L86) | Efficiency of capital allocation (D61) |
| Efficiency of capital allocation (D61) | Higher rates of growth in income and productivity (O49) |
| Improved monitoring technologies (L63) | Reduced rents earned by firms (R38) |
| Improved monitoring technologies (L63) | Transition from credit-rationing equilibrium to perfectly efficient competitive equilibrium (D53) |
| Decrease in the wedge between internal rate of return earned by firms and the rate of return received by savers (G19) | Rise in the economy's capital stock (E22) |
| Financial development (O16) | Economic development (O29) |