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Should Wall-Street be occupied ? an overlooked price externality of financial intermediation
 
Author:Eden, Maya; Collection Title:Policy Research working paper ; no. WPS 6059Paper is funded by the Knowledge for Change Program (KCP)
Country:World; Date Stored:2012/10/18
Document Date:2012/05/01Document Type:Policy Research Working Paper
SubTopics:Access to Finance; Islamic Finance; Economic Theory & Research; Markets and Market Access; Fiscal & Monetary PolicyLanguage:English
Region:The World RegionReport Number:WPS6059
Volume No:1 of 1  

Summary: Does an unregulated financial system absorb too many productive inputs? This paper studies this question in the context of a dynamic model with heterogeneous producers. In the absence of a financial system, the only way to purchase inputs is using internal funds. Producers are subject to idiosyncratic productivity shocks, and will decide to produce only if their productivity is high enough. Otherwise, they will hold money. A financial intermediation technology allows producers to purchase inputs in excess of their internal funds, by borrowing from unproductive agents. However, intermediation requires the use of costly monitoring services. In equilibrium, intermediation increases the money in circulation and raises nominal prices, thereby reducing the value of internal funds and making producers increasingly reliant on costly monitoring services. For this reason, society is better off when intermediation is restricted.

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