User Costs, the Financial Firm, and Monetary and Regulatory Policy

Abstract

We investigate how key monetary policy instruments and financial regulation affect the banking firm. We take the user cost approach to the construction of prices for financial services and use quarterly data on the U.S. commercial banking sector, over the period from 1992 to 2016, obtained from the Federal Deposit Insurance Corporation. We use the symmetric generalized Barnett variable profit function to derive demands for and supplies of monetary and non-monetary goods and provide evidence consistent with neoclassical microeconomic theory. We find that the compensated price elasticities of banking technology are small in magnitude. Yet a hypothetical policy experiment shows that even small changes in the holding costs of financial goods can result in significant changes in user costs and the quantities demanded and supplied.

Keywords: Commercial Banks; Generalized Barnett Variable Profit Function; Flexible Functional Forms

JEL Classification: E5; G2; D2; C3