On a Pecuniary Externality of Competitive Banking Through Goods Pricing Dispersion

Abstract

AbstractWe show that even with idealized competitive banks, banking amplifies retail-goods firms' ability to extract higher markups from ex-post heterogeneous buyers. This works through a new pecuniary-externality channel that is tightly connected to an equilibrium distribution of goods-price markups. Our model generates a positive relationship between the consumer credit-to-GDP ratio and goods-price markups (and their dispersion). This prediction is consistent with empirical evidence using firm-level data in the United States. The endogeneity in firms' markup responses to the presence of credit renders banking not always and everywhere a welfare-enhancing proposition. Consequently, the welfare-improving role of banks as intermediaries that help alleviate individual liquidity risk is ambiguous. Our model also justifies why policymakers should be worried about inflation, banking and its connection to rising industry markups.

Keywords: Banking and Credit, Markups, Market Power, Price Dispersion