nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2022‒06‒13
twenty-six papers chosen by
Georg Man

  1. Financial Development and Income Inequality: Evidence from Advanced, Emerging and Developing Economies By Carolyn Chisadza; Mduduzi Biyase
  2. Remittances and Income Inequality in Africa: Financial Development Thresholds for Economic Policy By Ofori, Isaac K.; Gbolonyo, Emmanuel; Dossou, Marcel A.; Nkrumah, Richard K.
  3. Spatial Effects of Foreign Direct Investment Flows on Industrial Performance in Sub-Saharan African Countries By Kirsi Zongo; Mahamadou Diarra
  4. Offshoring via vertical FDI in a long-run Kaleckian model By Woodgate, Ryan
  5. The Financial Resource Curse Revisited: The Supply-Side Effect of Low Interest Rates By Simon Hildebrandt; Jochen Michaelis
  6. Green credit policy and total factor productivity: Evidence from Chinese listed companies By Shu, Guo; ZhongXiang, Zhang
  7. Effectiveness of Monetary Policy in Stimulating Economic Growth in Nigeria By Igbafe, Timothy
  8. Output Divergence in Fixed Exchange Rate Regimes: Is the Euro Area Growing Apart? By Yao Chen; Felix Ward
  9. International Portfolio Rebalancing and Fiscal Policy Spillovers By Sami Alpanda; Uluc Aysun; Serdar Kabaca
  10. Risk Through the Looking-Glass the pursuit of a return without the risk! From wealth creation to wealth extraction By Savvakis C. Savvides
  11. Estimation of Economic Opportunity Cost of Capital: An Operational Guide for Mozambique By Abdullah Othman; Glenn P. Jenkins; Mikhail Miklyaev
  12. Effectiveness and conduct of macroprudential policy in Indonesia in 2003-2020: Evidence from the structural VAR models By Dąbrowski, Marek A.; Widiantoro, Dimas Mukhlas
  13. Enhancing Stress Tests by Adding Macroprudential Elements By William F. Bassett; David E. Rappoport
  14. Optimal bank capital requirements: What do the macroeconomic models say? By Gulan, Adam; Jokivuolle, Esa; Verona, Fabio
  15. What Drives Credit Risk? Empirical Evidence from Southeast Europe By Nikola Fabris; Nina Vujanović
  16. How Does the Economic Uncertainty Affect Asset Prices under Normal and Financial Distress Times? By Balcilar, Mehmet; Ozdemir, Zeynel Abidin; Ozdemir, Huseyin; Aygun, Gurcan; Wohar, Mark E.
  17. Financial cycles under diagnostic beliefs By Camous, Antoine; Van der Ghote, Alejandro
  18. The Collateral Channel and Bank Credit By Arun Gupta; Horacio Sapriza; Vladimir Yankov
  19. Alternative Measures for the Global Financial Cycle: Do They Make a Difference? By Xin Tian; Jan Jacobs; Jakob de Haan
  20. A Wake-Up Call Theory of Contagion By Ahnert, Toni; Bertsch, Christoph
  21. Cross-Sector Interactions in Western Europe: Lessons From Trade Credit Data By Melina London
  22. Financial Innovations in a World with Limited Commitment: Implications for Inequality and Welfare By Saroj Dhital; Pedro Gomis-Porqueras; Joseph H. Haslag
  23. Cryptocurrencies and Decentralized Finance (DeFi) By Igor Makarov; Antoinette Schoar
  24. Why bank money creation? By Gersbach, Hans; Zelzner, Sebastian
  25. Central Bank Digital Currency: Stability and Information By Todd Keister; Cyril Monnet
  26. The digital economy, privacy, and CBDC By Ahnert, Toni; Hoffmann, Peter; Monnet, Cyril

  1. By: Carolyn Chisadza (Department of Economics, University of Pretoria, Pretoria, South Africa); Mduduzi Biyase (Director of the Economic Development and Well-being Research Group (EDWRG); Senior lecturer at the School of Economics, University of Johannesburg)
    Abstract: Using a broad-based index of financial development, this paper investigates the effects of financial development on income inequality for 148 countries between 1980 and 2019. The findings indicate that in general, financial development reduces inequality across emerging and least developed countries, but is not statistically significant for advanced countries. However, when we disaggregate the financial development index into its sub-components (financial institutions and financial markets), we find different effects on inequality, based on the levels of development. Further investigation on the dimensions under financial institutions and financial markets (depth, access and efficiency) reveals that banking sector development under financial institutions has income inequality-reducing effects in emerging and least developed countries, while stock market development under financial markets widens inequality in least developed countries. The findings in our paper firstly highlight the nuances in financial development depending on the level of development in countries, and secondly that policies focussed on financial inclusion of the poor can mitigate inequality.
    Keywords: financial development, financial markets, inequality, financial institutions
    JEL: C22 D63 G20 O55
    Date: 2022–04
  2. By: Ofori, Isaac K.; Gbolonyo, Emmanuel; Dossou, Marcel A.; Nkrumah, Richard K.
    Abstract: The study employs macrodata on 42 African countries to examine whether remittances and financial development (including the sub-components of access, depth and efficiency) contribute to the equalisation of incomes across the continent. Robust evidence from the dynamic GMM estimator shows that: (i) remittances heighten income inequality in Africa, (ii) Africa’s financial system is not potent enough for repacking remittances towards the equalisation of incomes, and (iii) vis-à-vis financial access and depth, inefficiencies characterising Africa’s financial institution is the main reason remittances contribute to the widening of the income disparity gap. Nonetheless, the optimism which we provide by way of threshold analysis shows that channelling efforts into the development of Africa’s financial sector could yield shared income distribution dividends. In particular, efforts should be made to achieve a minimum of 23.05 per cent of financial access, and 3.02 per cent for that of efficiency of financial institutions if Africa’s financial sector is to repackage external finance towards the equalisation of incomes. A few policy recommendations are provided in the end.
    Keywords: Africa,Financial Development,Financial Sector Efficiency,Income Inequality,Remittances
    JEL: F22 F24 G21 I3 N37 O11 O55
    Date: 2022
  3. By: Kirsi Zongo (Université Norbert ZONGO de Koudougou); Mahamadou Diarra (Université Norbert ZONGO de Koudougou)
    Abstract: This paper rigorously analyzes the effects of foreign direct investment inflows on the industrial performance in the Sub-Saharan African (SSA) economies. Applying the Durbin spatial method (SDM) on a two-sector model to account for spatial effects, the empirical results show that the higher the capacity of SSA countries to attract foreign investments, the higher is the job-inducing effect and value-added created in the industrial sector, while no technology transfer was induced. This finding highlights the importance for the countries of sub-Saharan Africa to direct foreign direct investment towards strategic sectors where they benefit from comparative advantages and improve the business climate to attract more FDI, a pledge of any industrial development.
    Keywords: Spatial Econometrics,Industrial Performance,Foreign Direct Investment
    Date: 2022–03–23
  4. By: Woodgate, Ryan
    Abstract: This paper develops a two-country Kaleckian model in which "Northern" firms invest a fixed fraction of total investment in foreign affiliates in the low-wage "South" in order to offshore the production of intermediate goods over time and lower overall labour costs. On the back of this setup follows an analysis of the macroeconomic implications of offshoring in the short and long run. Offshoring through vertical FDI is found to lead to a falling wage share and a simultaneously falling price level and rising mark-up in the North, whereas the effect on equilibrium capacity utilisation may be positive or negative. Interestingly, however, regardless of the effect on capacity utilisation and firm profitability, we can show that the structural change implied by offshoring leads to lower rates of capital accumulation and employment in the North relative to the initial (pre-offshoring) values in the short run. The long-run effects on Northern employment and growth, on the other hand, depend crucially on the long-run accumulation rate of the Northern-owned multinational firms. However, the model shows that, if wages endogenously converge during the transition due to higher unemployment in the North and lower unemployment in the South, then the long-run Northern capacity utilisation and accumulation rates are increasingly likely to fall relative to pre-offshoring values. The model appears well suited to shed light on many real-world macroeconomic phenomena, such as rising FDI flows, falling wage shares, rising mark-ups in an era of low inflation, hysteresis, and secular stagnation.
    Keywords: offshoring,foreign direct investment,distribution,stagnation
    JEL: F62 F23 O41 E11 E12
    Date: 2022
  5. By: Simon Hildebrandt (University of Kassel); Jochen Michaelis (University of Kassel)
    Abstract: Benigno and Fornaro (2014) show that an episode of low interest rates may harm an economy. Low interest rates trigger a consumption boom, labor shifts away from the tradable sector, learning spillovers from foreign technology decline and so do domestic total factor productivity, consumption and welfare. In this paper, we show that their conclusion of a financial resource curse does not hold in a world with capital as production factor. Low interest rates now trigger an investment boom, there is no shift of labor between sectors, total factor productivity remains unaffected. Our model confirms “textbook wisdom†, i.e., an episode of low interest rates enhances welfare in a small open economy.
    Keywords: capital accumulation, endogenous growth, macroeconomic integration
    JEL: E22 F36 F43
    Date: 2022
  6. By: Shu, Guo; ZhongXiang, Zhang
    Abstract: The green credit policy plays a vital role in promoting enterprise upgrading. Using a thirteen year panel data of listed companies in China (2007 2019), this study uses the difference in differences (DID) method to examine the effects of the Green Credit Guidelines in 2012 (GCG2012) on the firm level total factor productivity (TFP). Our results show that the GCG2012 significantly increases the TFP of companies in green credit restricted industries. This finding remains robust through employing the PSM-DID model, alternating the treatment group, changing the sample period, and controlling the effects of other environmental policies and financial crises. This effect is more pronounced for private enterprises, companies with worse debt paying ability, companies in highly competitive industries and companies in regions with higher financial liberalization. The impact mechanism test indicates that increasing the green innovation and reducing the agency costs (including green agency costs and traditional agency costs) are two possible channels to boost firm level TFP. Further analysis shows that the GCG2012 is effective not only for heavily polluting industries but also for light polluting industries, and that the GCG2012 can improve the economic performance of firms in green credit restricted industries. Overall, this study reveals the micro mechanisms behind the long term impact of the GCG2012 policy on firm level TFP, providing empirical evidence and policy suggestions for improving green credit policies and promoting green development.
    Keywords: Environmental Economics and Policy, Production Economics, Productivity Analysis
    Date: 2022–05–31
  7. By: Igbafe, Timothy
    Abstract: This study examined the effectiveness of monetary policy in stimulating economic growth in Nigeria between 1990 and 2019. Secondary data were sourced mainly from CBN publications. The theoretical framework was based on the Keynesian transmission mechanism. In the cause of empirical investigation, various advanced econometric techniques like Augmented Dickey Fuller Unit Root Test, ARDL Bounds Test and Error Correction Mechanism (ECM) were employed and the result revealed that all the variables were stationary at first difference except monetary policy rate that was stationary at level, meaning that the variables were integrated of different order justifying ARDL Bounds Test and error correction mechanism test. The ARDL Bounds Test result indicated that there is long run relationship among the variables with the lower bound and upper bound less than the calculated at 5% level of significant. The result of the error correction mechanism (ECM) test indicates an 88% adjustment back to equilibrium. It is therefore recommended that since economic growth in Nigeria is greatly influenced in the long-run by interest rate and reserve requirement making monetary policy an effective tool in stimulating economic growth. Nigerian government through its monetary authorities should unveil other policies that will stimulate economic growth not only in the long run but also, in the short run period.
    Keywords: Monetary policy Economic Growth Time Series Dat Error Correction Model.
    JEL: G00
    Date: 2022–01
  8. By: Yao Chen (Erasmus University Rotterdam); Felix Ward (Erasmus University Rotterdam)
    Abstract: Can fixed exchange rate regimes cause output divergence among member states? We show that such divergence is a long-run equilibrium characteristic of a two-region model with fixed exchange rates, heterogeneous labor markets, and endogenous growth. Under flexible exchange rates, monetary policy closes output gaps and realizes the associated maximum TFP growth in both regions. Upon fixing exchange rates, the region with higher structural wage inflation falls into a low-growth trap. When calibrated to the euro area, the model implies a slowdown in the TFP growth rate of the euro areaÕs periphery relative to its core. An empirical analysis confirms that the peripheryÕs higher structural wage inflation rate contributed to its lower TFP growth in the aftermath of joining the euro.
    Keywords: Exchange rate, growth, monetary policy
    JEL: E50 F31 O40
    Date: 2022–04–28
  9. By: Sami Alpanda (University of Central Florida, Orlando, FL); Uluc Aysun (University of Central Florida, Orlando, FL); Serdar Kabaca (Bank of Canada, Ottawa, Canada)
    Abstract: We theoretically and empirically evaluate the spillover effects of debt-financed fiscal policy interventions of the United States on other economies. We first consider a two-country dynamic stochastic general equilibrium model with international portfolio rebalancing effects arising from an imperfect substitutability between short- and long-term domestic and foreign bonds. The model shows that US fiscal expansions financed by long-term debt issuance would, on net, hinder economic activity in the rest of the world (ROW). This is despite the standard trade channel’s net positive effect on the ROW economy given the depreciation in the ROW currency. The fall in ROW output occurs mainly due to the increase in the ROW term premia and long-term rates through the portfolio rebalancing channel, as the relative demand for ROW long-term bonds decreases following the increase in the supply of US long-term bonds accompanying the fiscal expansion. Testing the predictions of our theoretical model by using panel regressions and vector autoregressions, we find empirical support for the negative relationship between ROW output and US fiscal spending. The data also confirm the positive relationship between ROW term spreads and US fiscal spending.
    Keywords: International portfolio rebalancing, international spillover effects of fiscal policy, preferred habitat, DSGE.
    JEL: E62 F41 F42
    Date: 2022–05
  10. By: Savvakis C. Savvides (Visiting Lecturer, John Deutsch Institute for the Study of Economic Policy, Queen’s University, Canada)
    Abstract: The question of what is really risk in capital investments is posed and discussed. It suggests that the almost total acceptance of the concept that volatility constitutes a good measure of risk is wrong and leads towards a misallocation of economic resources. It is argued that that the Expected Loss of a capital investment project should be used as a measure of risk. It is further illustrated how the risk aversion attitudes of potential investors can be taken into consideration in the decision to invest or not. The pursuit of return without risk inevitably leads to the transfer of wealth through a failing banking system which collaborates with an unregulated financial market who constantly seek low risk and relatively safe returns for the benefit of their wealthy clients. It is further argued that wasteful finance impairs the real economy and inevitably brings about financial crises and economic recessions. The promise of a “return without the risk†leads financial intermediaries in the direction of an elusive quest whereby the only way to attain this is through directing funding towards the capture of existing assets rather than investing in the real economy to create new wealth.
    Keywords: Economic development, repayment capability, project evaluation, corporate lending, credit risk.
    JEL: D61 G17 G21 G32 G33 H43
    Date: 2022–04–18
  11. By: Abdullah Othman (Cambridge Resources International Inc.); Glenn P. Jenkins (Department of Economics, Queens University, Kingston, Ontario, Canada, K7L3N6 and Cambridge Resources International Inc.); Mikhail Miklyaev (Department of Economics, Queens University, Kingston, Ontario, Canada, K7L3N6 and Cambridge Resources International Inc.)
    Abstract: In this paper, an analytical framework and a practical approach are developed to measure the economic opportunity cost of capital (EOCK). This national parameter is an essential determinant for practical application to the economic appraisal of investment projects in a consistent manner for a country. An application of the model is carried out for Mozambique since Mozambique is a small open economy and is also integrated into the global capital market. Estimate of the EOCK is based on the hypothesis that when funds are raised in the capital market to finance any investment project, those funds are likely to come from displaced investment, newly stimulated domestic savings, and newly stimulated foreign capital inflows. It can then be estimated as a weighted average of the opportunity cost of each of the three alternative sources of funds. The EOCK is the most appropriate rate used to discount the economic benefits and costs of a project to see if the project is economically viable for society as a whole.
    Keywords: Capital Market, Discount Rate, Investment Funds, Investment Projects, Economic Growth, Mozambique
    JEL: H43 O22
    Date: 2022–04–18
  12. By: Dąbrowski, Marek A.; Widiantoro, Dimas Mukhlas
    Abstract: The paper examines the effectiveness of macroprudential policy in Indonesia and policy reactions to economic developments. Using the structural vector autoregression and data on the regulatory LTV ratio, we investigate the policy effectiveness in controlling credit growth and real property prices along with the effects on economic activity. We find that the LTV-based policy in Indonesia is effective in taming credit growth in the medium run. It, however, is not the case with real property prices whose response to policy changes is counterintuitive and resembles the price puzzle found in the studies on monetary policy. Moreover, our results lend moderate support to the effect of LTV policy on economic activity, especially in the non-Covid-19 sample. We also show that the LTV policy in Indonesia is conducted in an active and circumspective way. In a series of robustness checks, we demonstrate that the results hold when the ordering of variables is changed, alternative proxies for macroprudential policy, output gap, and financial conditions are employed, or the sample is limited to the non-Covid-19 period.
    Keywords: macroprudential policy; loan-to-value policy; structural vector autoregressive models; financial stability
    JEL: E44 E58 F41 G10
    Date: 2022–05–05
  13. By: William F. Bassett; David E. Rappoport
    Abstract: The use of stress testing for macroprudential objectives is advanced by modeling spillovers within the financial sector or between the real and financial sectors. In this chapter, we discuss several macroprudential elements that capture these spillovers and how they might be added to stress test frameworks. We show how funding spillovers can be modeled as an add-on, using a reduced-form relation between banks' funding cost, bank capital and economic activity. Using a calibration to US data, we project very modest funding spillovers conditional on the DFAST 2018 severely adverse scenario. We describe the pros and cons of modeling different types of spillovers using this approach.
    Keywords: Bank capital; Funding shocks; Macroprudential policy; Stress testing
    JEL: E58 G28
    Date: 2022–05–06
  14. By: Gulan, Adam; Jokivuolle, Esa; Verona, Fabio
    Abstract: The optimal level of banks' capital requirements has been a key research topic since at least the introduction of the Basel rules in the late 1980s. In this paper, we review the literature, focusing on recent findings from quantitative structural macroeconomic models. While dynamic stochastic general equilibrium models capture second-round (general equilibrium) effects such as the feedback effects from macroeconomic outcomes back to financial intermediation and the dynamic evolution of the economy following regulatory changes, they suffer from tractability issues, including treatment of nonlinear effects, that typically force modeling simplifications. Additionally, studies tend to be concerned with determining the optimal level of fixed capital requirements. Only a handful offer estimates of the optimal size of the dynamic buffers. Since optimal dynamic macroprudential policies depend heavily on the nature of the underlying shocks, questions arise regarding the robustness and potential side effects of such plicies. Despite progress, the optimal level of bank capital requirements - in either fixed or dynamic form - remains largely an open research question.
    Date: 2022
  15. By: Nikola Fabris; Nina Vujanović (The Vienna Institute for International Economic Studies, wiiw)
    Abstract: Bank stability is an important aspect of financial stability, especially in bank-centric systems such as those in Southeast Europe. The financial crisis has shown that there is a particular need to monitor credit and other similar risks. Hence, it is important to analyse risks affecting the stability of both the banking sector and the financial system as a whole. To that end, central banks have developed macroprudential policies aiming to safeguard financial stability. However, little is known about the drivers of some financial risks. In that context, this study analyses the determinants of credit risk, which is the most prominent risk in the banking sectors of three selected Southeast European economies – Montenegro, Kosovo* and Bosnia and Herzegovina. Dynamic panel data techniques were applied to 48 banks, which represent almost the entire banking sectors in the respective countries. The empirical evidence has shown that both macroeconomic and bank-specific determinants represent influential factors driving credit risk in Southeast Europe. Particularly important macroeconomic factors affecting credit risk are business cycle and sovereign debt. On the other hand, bank size, capital levels, credit activity and profitability are the most prominent factors influencing credit risk in the region.
    Keywords: Credit Risk, Financial Stability, Southeast Europe, Banking
    JEL: G21 E37
    Date: 2022–05
  16. By: Balcilar, Mehmet (Eastern Mediterranean University); Ozdemir, Zeynel Abidin (Ankara HBV University); Ozdemir, Huseyin (Gazi University); Aygun, Gurcan (Gazi University); Wohar, Mark E. (University of Nebraska Omaha)
    Abstract: By using a nonlinear VAR model, we investigate whether the response of the US stock and housing markets to uncertainty shocks depends on financial conditions. Our model allows us to change the response of the US financial markets to volatility shocks in periods of normal and financial distress. We find strong evidence that uncertainty shocks have adverse effects on the US financial markets, irrespective of financial conditions. Moreover, our empirical results show that the rebound in US housing prices, which fell sharply in the economic turmoil, is state-dependent. This reflects the Fed's expansionary monetary policy to stabilize the US housing market. Furthermore, our findings reveal that economic agents who closely monitor the impact of uncertainty on the US stock and housing markets should also consider financial frictions in the US economy.
    Keywords: asset prices, economic uncertainty, financial conditions, regime switching, US
    JEL: C32 E32 E44 G01 G12 R31
    Date: 2022–05
  17. By: Camous, Antoine; Van der Ghote, Alejandro
    Abstract: Swift changes in investors' sentiment, such as the one triggered by COVID-19 global outbreak in March 2020, lead to financial tensions and asset price volatility. We study the interactions of behavioral and financial frictions in an environment with endogenous risk-taking and capital accumulation. Agents form diagnostic expectations about future stochastic outcomes: recent realizations of aggregate shocks are expected to persist. This behavioral friction gives rise to sentiment cycles with excessive investment and occasional safety traps. The interactions with financial frictions lead to an endogenous amplification of financial instability. We discuss implications for policy interventions. JEL Classification: E32, E44, E71
    Keywords: diagnostic beliefs, financial cycles, macro-prudential policy
    Date: 2022–05
  18. By: Arun Gupta; Horacio Sapriza; Vladimir Yankov
    Abstract: Our paper studies the role of the collateral channel for bank credit using confidential bank-firm-loan data. We estimate that for a 1 percent increase in collateral values, firms pledging real estate collateral experience a 12 basis point higher growth in bank lending with higher sensitivities for more credit constrained firms. Higher real estate values boost firm capital expenditures and lead to lower unemployment and higher employment growth and business creation. Our estimates imply that as much as 37 percent of employment growth over the period from 2013 to 2019 can be attributed to the relaxation of borrowing constraints.
    Keywords: Collateral channel; Firm borrowing constraints; Bank credit allocation; Corporate investment; Macro-finance; Transmission mechanism
    JEL: E44 G21
    Date: 2022–05–10
  19. By: Xin Tian; Jan Jacobs; Jakob de Haan
    Abstract: We construct several measures for the global financial cycle using dynamic factor models and data for 25 advanced and emerging countries over 1980-2019. Our results suggest that global cycles in asset prices and capital flows are highly similar and synchronized, especially during crisis episodes. Our measures for asset-specific global cycles suggest that cycles in credit and house prices are less volatile and have a longer duration than cycles in equity and bond prices. Finally, we find significant co-movement of our global financial cycle measures and two measures as suggested in the literature that are based on top-down and bottom-up approaches.
    Keywords: global financial cycle, national financial cycle, dynamic factor analysis, capital flows, asset prices
    JEL: E44 F32 F36
    Date: 2022
  20. By: Ahnert, Toni; Bertsch, Christoph
    Abstract: We offer a theory of financial contagion based on the information choice of investors after observing a financial crisis elsewhere. We study global coordination games of regime change in two regions linked by an initially unobserved macro shock. A crisis in region 1 is a wake-up call to investors in region 2. It induces them to reassess the regional fundamental and acquire information about the macro shock. Contagion can occur even after investors learn that region 2 has no ex-post exposure to region 1. We explore normative and testable implications of the model. In particular, our results rationalize evidence about contagious currency crises and bank runs after wake-up calls and provide some guidance for future empirical work. JEL Classification: D83, F3, G01, G21
    Keywords: bank run, contagion, financial crises, fundamental re-assessment., global games, information choice, wake-up call
    Date: 2022–05
  21. By: Melina London (Aix Marseille University, CNRS, AMSE, Marseille, France.)
    Abstract: Large-scale analyses to map interactions between financial health at the sectoral level are still scarce. To fill the gap, in this paper, I map a network of predictive relationships across the financial health of several sectors. I provide a new advanced indicator to track propagation of financial distress across industries and countries on a monthly basis. I use defaults on trade credit as a measure of firms’ worsening financial conditions in a sector. To control for omitted-variable bias, I apply a high- dimensional VAR analysis, and isolate direct cross-sector causalities `a la Granger from common exposure to macroeconomic shocks or to third-sector shock. I show that monitoring some key sectors–among which construction, wholesale and retail, or the automotive sector–can improve the detection of financial distress in other sectors. Finally, I find that those financial predictive relationships correlates with the input-output structure in the considered economies. Such structure of financial interactions reflect the propagation of financial distress along the supply chain.
    Keywords: trade credit; network; cross-sector financial interdependencies
    JEL: F14 F36 F44 L14
    Date: 2022–05
  22. By: Saroj Dhital (Economics and Business Department, Southwestern University); Pedro Gomis-Porqueras (School of Economics and Finance, Queensland University of Technology, Brisbane, Australia); Joseph H. Haslag (Department of Economics, University of Missouri-Columbia)
    Abstract: Do financial innovations benefit or harm expected welfare? For innovations that provide greater access to banks, researchers have argued that lower transaction costs and better project assessments result in expected welfare gains. Others, however, have shown that with incomplete markets, financial innovations result in expected welfare losses. In this paper, we examine the impacts of financial innovations in economies with incomplete markets and limited commitment. We show that the results critically depend on whether assets are priced fundamentally or not. When priced fundamentally, greater access does improve expected welfare, also resulting in greater consumption inequality. However, when assets carry a premium, there is an additional channel owing to limited commitment. Because of a more severe limited commitment problem, collateral is necessary. A fixed quantity of pledgeable assets are spread across a larger measure of depositors, resulting in less consumption for those with access to banks and consumption inequality decreases. Second, we consider a financial innovation that increases the pledegeability of one type of bank collateral. We also show that the results critically depend on whether assets are priced fundamentally or not. When assets are priced fundamentally, this type of financial innovation does not change welfare nor consumption inequality. In contrast, when assets carry a premium, better collateral results in more consumption for depositors with access to the more sophisticated payment option. We extend our model economy to consider an endogenous decision to access checkable deposits. This allows us to examine the effects of changes in the distribution of costs that are important to the choice of participating in observing buyers’ deposit or not. Third, our analysis demonstrates that collateral in a limited commitment framework provides a mechanism through which financial innovation can increase or decrease the impact that financial innovations have on welfare and inequality.
    Keywords: welfare, financial innovation, financial access, inequality
    JEL: E40 E61 E62 H21
    Date: 2022–05
  23. By: Igor Makarov; Antoinette Schoar
    Abstract: The paper provides an overview of cryptocurrencies and decentralized finance. The discussion lays out potential benefits and challenges of the new system and presents a comparison to the traditional system of financial intermediation. Our analysis highlights that while the DeFi architecture might have the potential to reduce transaction costs, similar to the traditional financial system, there are several layers where rents can accumulate due to endogenous constraints to competition. We show that the permissionless and pseudonymous design of DeFi generates challenges for enforcing tax compliance, anti-money laundering laws, and preventing financial malfeasance. We highlight ways to regulate the DeFi system which would preserve a majority of benefits of the underlying blockchain architecture but support accountability and regulatory compliance.
    JEL: G1 G2 G20 G21 G23 G3
    Date: 2022–04
  24. By: Gersbach, Hans; Zelzner, Sebastian
    Abstract: We provide a rationale for bank money creation in our current monetary system by investigating its merits over a system with banks as intermediaries of loanable funds. The latter system could result when CBDCs are introduced. In the loanable funds system, households limit banks' leverage ratios when providing deposits to make sure they have enough "skin in the game" to opt for loan monitoring. When there is unobservable heterogeneity among banks with regard to their (opportunity) costs from monitoring, aggregate lending to bank-dependent firms is inefficiently low. A monetary system with bank money creation alleviates this problem, as banks can initiate lending by creating bank deposits without relying on household funding. With a suitable regulatory leverage constraint, the gains from higher lending by banks with a high repayment pledgeability outweigh losses from banks which are less diligent in monitoring. Bank-risk assessments, combined with appropriate risksensitive capital requirements, can reduce or even eliminate such losses.
    Keywords: monetary system,banking,money creation,loanable funds,capitalrequirements,leverage constraint,asymmetric information,moral hazard,CBDC
    JEL: E42 E44 E51 G21 G28
    Date: 2022
  25. By: Todd Keister (Rutgers University); Cyril Monnet (University of Bern, Study Center Gerzensee, Swiss National Bank)
    Abstract: We study how the introduction of a central bank digital currency (CBDC) would affect the stability of the banking system. We present a model that captures a concern commonly raised in policy discussions: the option to hold CBDC can increase the in- centive for depositors to run on weak banks. Our model highlights two countervailing effects. First, banks do less maturity transformation when depositors have access to CBDC, which leaves them less exposed to depositor runs. Second, monitoring the flow of funds into CBDC allows policymakers to more quickly identify weak banks and take appropriate action, which also decreases the incentive for depositors to run. Our results suggest that a well-designed CBDC may decrease rather than increase financial fragility.
    Date: 2022–05
  26. By: Ahnert, Toni; Hoffmann, Peter; Monnet, Cyril
    Abstract: We study a model of financial intermediation, payment choice, and privacy in the digital economy. Cash preserves anonymity but cannot be used for more efficient online transactions. By contrast, bank deposits can be used online but do not preserve anonymity. Banks use the information contained in deposit flows to extract rents from merchants in need of financing. Payment tokens issued by digital platforms allow merchants to hide from banks but enable platforms to stifle competition. An independent digital payment instrument (a CBDC) that allows agents to share their payment data with selected parties can overcome all frictions and achieves the efficient allocation. JEL Classification: D82, E42, E58, G21
    Keywords: central bank digital currency, digital platforms, financial intermediation, payments, privacy
    Date: 2022–05

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