Endogenous Finance and Policy Interactions: Monetary Policy, Financial Regulation, and Competition Policy

Abstract

This paper analyzes a vertical market structure in which downstream firms compete imperfectly in quantities while upstream banks endogenously determine loan rates. Banks' pricing depends on the policy rate, lending volume, and banking conduct (profit-maximizing versus contestable). With contestable banking, average-cost loan pricing creates feedback between lending and loan rates, making monetary transmission state-dependent. We show that monetary policy, financial regulation, and competition policy-typically delegated to separate authorities-interact non-additively through this upstream channel. Tighter financial regulation amplifies monetary transmission under contestable banking; competition policy can either strengthen or weaken it depending on banking pass-through. These results imply that policy evaluation requires treating the three instruments as a mix rather than in isolation. Extensions with default risk show that policy tightening and weaker competition can be welfare-improving.

Keywords: Imperfect Competition, Endogenous Finance, Monetary Transmission, Financial Regulation, Competition Policy

JEL Classification: D43, G21, L13