Bank competition, real investments, and welfare
We construct an overlapping generations growth model, where young consumers choose how to allocate resources among real investment (deposits), acquisition of bank ownership, and young-age consumption. At old age, consumers sell bank ownership and collect their bank deposits to support consumption. The model shows that an increase in banks’ market power stimulates bank profit and bank value, thereby raising the resources required for young consumers to acquire bank ownership. This causes a crowding-out effect on real investment, the magnitude of which is amplified with higher endowment growth rate and real investment return. Finally, we conduct a welfare analysis of the investment crowding-out effect.
KeywordsInvestment crowding-out Size of the banking sector Deposit market competition Economic growth
JEL ClassificationG21 O41
We are deeply indebted to two anonymous referees for their extensive guidance and proposed modifications that greatly improved this article. We also thank seminar participants at Tufts University and the Bank of Canada for valuable comments. Special thanks to Sofia Priazhkina and Maarten van Oordt for valuable suggestions. Rune Stenbacka acknowledges financial support from Suomen Arvopaperimarkkinoiden Edistamissaatio. The work on this project has started while Oz Shy was teaching at MIT Sloan School of Management.
- Carpenter S, Demiralp S (2010) Money, reserves, and the transmission of monetary policy: does the money multiplier exist?. Finance and economics discussion series. Federal Reserve Board, Washington, Discussion paper no. 2010–41Google Scholar
- Cecchetti S, Kharroubi E (2012) Reassessing the impact of finance on growth. BIS working paper no. 381Google Scholar
- Cecchetti S, Kharroubi E (2015) Why does financial sector growth crowd out real economic growth?. BIS working paper no. 490Google Scholar
- Kay J (2015) Other people’s money: the real business of finance. PublicAffairs, New YorkGoogle Scholar
- Kehoe T (1989) Intertemporal general equilibrium models. In: Hahn F (ed) The economics of missing markets, information, and games. Oxford University Press, pp 363–393Google Scholar
- King M (2016) The end of alchemy: money, banking, and the future of the global economy. WW Norton and Company, New YorkGoogle Scholar
- McCandless G, Wallace N (1991) Introduction to dynamic macroeconomic theory: an overlapping generations approach. Harvard University Press, CambridgeGoogle Scholar
- McLeay M, Amar R, Thomas R (2014) Money creation in the modern economy. Bank Engl Q Bull Q1:14–27Google Scholar
- Tobin J (1984) On the efficiency of the financial system. Lloyds Bank Rev 153:1–15Google Scholar