Endogenous Market Structures and Financial Development

Zsolt Becsi, Ping Wang, and Mark A. Wynne
Federal Reserve Bank of Atlanta
Working Paper 98-15
August 1998

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Existing theories that emphasize the significance of financial intermediation for economic development have not addressed two important empirical facts: (i) the relationship between financial and real activities depends crucially on the stage of development, and (ii) financial and industrial market structures vary widely across otherwise similar countries. To explain these observations, we develop a dynamic general equilibrium model allowing for endogenous market structures in which financial deepening spurs real activity through intermediate product broadening. We show the possibility of multiple steady-state equilibria and characterize how these equilibria respond to various shocks. In particular, we examine the determinants of financial deepening, product broadening, the saving rate, the loan-deposit interest rate spread, and the degree of competitiveness of financial and product markets. We find that the dynamic interactions between financial and real activities depend critically on the synergy of financial and industrial competitiveness.

JEL classification: E44, O41, L16

Key words: financial intermediation, economic development, imperfect competition

The authors gratefully acknowledge comments and suggestions from Phil Dybvig, Marco Espinosa, Derek Laing, Victor Li, Will Roberds, Peter Rousseau, Bruce Smith, Alan Stockman, and Steve Williamson as well as participants at the 1997 European Econometrics Society Meetings in Toulouse, the Midwest Mathematical Economics Conference at Washington University, the 1997 AEA Meetings in New Orleans, and seminars at Academia Sinica, the Atlanta Fed, the St. Louis Fed, and Penn State. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Banks of Atlanta or Dallas or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions of substance to Zsolt Becsi, Research Department, Federal Reserve Bank of Atlanta, 104 Marietta Street, N.W., Atlanta, Georgia 30303-2713, 402/521-8785, 404/498-8058 (fax), zsolt.becsi@atl.frb.org; Ping Wang, Department of Economics, Pennsylvania State University, University Park, Pennsylvania 16802, 814/865-1525, 814/863-4775 (fax), pxw4@psu.edu; or Mark A. Wynne, Research Department, Federal Reserve Bank of Dallas, 2200 N. Pearl Street, Dallas, Texas 75222, 214/922-5159, 214/922-5194 (fax), mark.a.wynne@dal.frb.org.