Working Paper: NBER ID: w15528
Authors: Katheryn N. Russ; Diego Valderrama
Abstract: We join the new trade theory with a model of choice between bank and bond financing to show the differential effects of financial policy on the distribution of firm size, welfare, aggregate output, gains from trade, and the real exchange rate in a small open economy. Increasing bank efficiency and reducing bond transaction costs both increase welfare but have opposite effects on the extensive margin of trade, aggregate exports, and the real exchange rate. Increasing the degree of trade openness increases firms' relative demand for bond versus bank financing. We identify a financial switching channel for gains from trade where increasing access to export markets allows firms to overcome high fixed costs of bond issuance to secure a lower marginal cost of capital.
Keywords: financial choice; trade; banking; bond market; welfare; firm size
JEL Codes: E44; F12; F4; F41; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increasing access to export markets (F10) | Lower marginal cost of capital (G31) |
| Increasing access to export markets (F10) | Shift in financing preferences from banks to bonds (G21) |
| Increasing bank efficiency (G21) | Increase in average capital-to-labor ratio (E22) |
| Reducing bond transaction costs (G12) | Increase in average capital-to-labor ratio (E22) |
| Increasing bank efficiency (G21) | Increase in aggregate output (E23) |
| Reducing bond transaction costs (G12) | Increase in aggregate output (E23) |
| Bond market development (G10) | Depreciation of the real exchange rate (F31) |
| Banking sector efficiency improvements (G21) | Appreciation of the real exchange rate (F31) |