Abstract
Recent decades have seen a substantial increase in the size and influence of the financial industry in advanced economies. Mainstream theory states that the financial sector can increase the efficiency and stability of the real economy by reducing informational asymmetries and transaction costs. Nevertheless, the rise of the financial industry has been accompanied by lower aggregate growth, increased inequality and declining financial stability. With this in mind, the main aim of the present article is to provide a different perspective on the rise of finance in developed countries, by focusing on the impact of financial markets on aggregate growth and economic (in)stability. Specifically, we analyse the role of the bargaining power of financial intermediaries in promoting (or reducing) the entrance of new enterprises in the market and find that the financial sector is essential for the good functioning of the real economy, but that an overdeveloped financial industry can reduce the incentive for new firms to start production, resulting in a negative impact on aggregate growth and economic stability.
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Notes
Jordà et al. (2017) provide additional data for developed countries.
In the text, we will use the terms financial intermediary, financial institution, and financial sector interchangeably. Conversely, we will refer to production units as firms, companies, and enterprises.
Moreover, firms do not need additional equity to cover the risk of default.
The maximum value is set equal to \(\frac{1}{\sigma }\) in order to normalise results.
Note that the equity of firms coincides with the endowment of entrepreneurs by construction.
Note that: \(\theta =0\implies I=\left[ 0,\frac{1}{\sigma }\right] =\mathbb {I}.\)
As before, this is due to the decreasing marginal productivity of the production function.
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Ciola, E. Financial sector bargaining power, aggregate growth and systemic risk. J Econ Interact Coord 15, 89–109 (2020). https://doi.org/10.1007/s11403-019-00270-5
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DOI: https://doi.org/10.1007/s11403-019-00270-5