Banks as Coordinators of Economic Growth and Stability: Microfoundation for Macroeconomy with Externality

Abstract:     
Competition among banks promotes growth and stability for an economy with production externality. Following Arrow and Debreu (1954), I formulate a standard growth model with externality — a two-period version of Romer (1986) — as a game among consumers, firms, and intermediaries. The Walrasian equilibrium, with an auctioneer, does not achieve the social optimum. Without an auctioneer or intermediaries, I show that no Nash equilibrium exists. With several banks strategically intermediating capital, a Nash equilibrium emerges with a realistic institution, i.e., an interbank market with a negotiation process in the loan market.The equilibrium outcome is uniquely determined and socially optimal.

Number of Pages in PDF File: 64

Keywords: bank competition, bank control, growth, instability, discontinuous game

JEL Classification: C72, D51, G21, O16, O41

Accepted Paper Series