Eden, Maya2012-06-292012-06-292012-05https://hdl.handle.net/10986/9358Does 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.CC BY 3.0 IGOAGGREGATE SUPPLYALLOCATION OF CAPITALALLOCATION OF RESOURCESAMOUNT OF CAPITALARBITRAGEARBITRAGE OPPORTUNITYASSET PRICEBAILOUTSBANKING INDUSTRYBENCHMARKBIDSBINDING CONSTRAINTBORROWINGBUDGET CONSTRAINTCAPITAL ACCUMULATIONCAPITAL ALLOCATIONCAPITAL COSTSCAPITAL MARKETCAPITAL PURCHASECAPITAL PURCHASESCAPITAL STOCKCOLLATERALCOMMERCIAL BANKSCONSUMERSCONSUMPTION SMOOTHINGCOORDINATION FAILURECOUNTERFEIT MONEYDEBTDEMAND FOR CAPITALDEMAND FOR SAVINGSDERIVATIVEDEVELOPMENT ECONOMICSDEVELOPMENT POLICYDISTRIBUTIONAL IMPLICATIONSECONOMIC DEVELOPMENTECONOMIC EFFICIENCYECONOMIC GROWTHECONOMIC THEORYECONOMICS RESEARCHEFFICIENT ALLOCATIONEMERGING MARKETENDOWMENTSENTREPRENEURSEQUILIBRIUMEQUILIBRIUM PRICESEXPECTED RETURNSEXTERNAL FUNDSEXTERNALITIESFEDERAL RESERVEFEDERAL RESERVE BANKFINANCIAL CRISESFINANCIAL CRISISFINANCIAL EXPERTISEFINANCIAL FRAGILITYFINANCIAL INSTRUMENTSFINANCIAL INTERMEDIATIONFINANCIAL MARKETSFINANCIAL REGULATIONFINANCIAL SECTORFINANCIAL SERVICESFINANCIAL SHOCKFINANCIAL SYSTEMFIXED COSTFULL EMPLOYMENTGDPGROWTH THEORYHOLDINGHOLDINGSHOUSEHOLD WEALTHIMPLICIT SUBSIDYINCOMEINCOME SHOCKSINDUSTRIAL LOANSINEFFICIENCYINEQUALITYINFLATIONINPUT PRICESINSURANCEINTERNAL FUNDSINTERNATIONAL BANKLENDERLENDERSLEVIESLIQUIDITYLIQUIDITY CONSTRAINTLIQUIDITY CONSTRAINTSLOANLOAN SIZELOANABLE FUNDSM1MACROECONOMIC MODELSMACROECONOMICSMARGINAL COSTMARGINAL COSTSMARGINAL UTILITYMARKET FAILURESMARKET PRICEMATHEMATICAL ECONOMICSMAXIMUM AMOUNTMICRO STRUCTUREMONETARY EQUILIBRIUMMONEY SUPPLIESMONEY SUPPLYMONITORING COSTMORAL HAZARDMORAL HAZARD PROBLEMOPTIMIZATIONPARTIAL EQUILIBRIUM ANALYSISPHYSICAL CAPITALPOLITICAL ECONOMYPORTFOLIOPRICE LEVELPRODUCTION INPUTSPRODUCTION OUTPUTPRODUCTIVE INVESTMENTPRODUCTIVE RESOURCESPRODUCTIVE USEPRODUCTIVITYPROFITABILITYRATE OF RETURNREAL INCOMERESERVERESERVE RATIORESERVE REQUIREMENTRESERVE REQUIREMENTSRESERVESRETURNSALES REVENUESSAVINGSSELF-FINANCESELF-FINANCINGSOCIAL WELFARESTRUCTURAL CHANGETITHETRANSITION ECONOMIESUSE OF DERIVATIVESUTILITY FUNCTIONVALUE ADDEDVALUE OF MONEYWEALTHWorld Bank10.1596/1813-9450-6059