38 Pages Posted: 30 Aug 2005
Date Written: March 23, 2005
We present a model in which the importance of financial intermediation for development can be measured. We generate differences in the quantity of financial intermediation by varying the degree to which loan contracts can be enforced. Economies where contracts are poorly enforced employ less capital and operate more inefficient technologies. Calibrated numerical simulations reveal that both channels are quantitatively important. Nevertheless, under standard technological assumptions, financial disruptions alone cannot generate all the output dispersion one observes in the data. Matching that dispersion requires a higher capital share or a lower elasticity of substitution between capital and labor than usually assumed. We find that modeling financial disruptions explicitly markedly increases the effect on output variation of changes in those parameters. Finance, that is, matters.
Keywords: Development, Finance, Limited Enforcement
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