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UNBUNDLING FINANCIAL IMPERFECTIONS: LENDING FRICTIONS VS. TRADING FRICTIONS

Published online by Cambridge University Press:  06 June 2017

Burak R. Uras
Burak R. Uras*
Affiliation:
Tilburg University
*
Address correspondence to: Department of Economics, Tilburg University, Room K322B, 5000 LE Tilburg, The Netherlands; e-mail: [email protected].
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Abstract

Two essential imperfections determine the degree of the financial sector development in an economy: lending frictions, which constrain the ability to extend loans to borrowers; and, trading frictions, which constrain the trading of these loans in secondary markets. I develop a dynamic general equilibrium model where long-term investment is the engine of growth to study macroeconomic consequences of financial development. In the model, long-term loans are extended to entrepreneurs in a primary market and then traded in a secondary market among financiers. In competitive equilibria, reductions in either lending or trading frictions enlarge the financial sector. Although financial deepening through low-cost lending is always welfare improving, financial deepening stimulated by low-cost trading could be detrimental to the society. I illustrate that a model qualitatively consistent with the U.S. financial development episode of the last 30 years should exhibit disproportionately large reductions in trading frictions relative to lending frictions.

Keywords

Long-Term InvestmentSecondary MarketsFinancial Frictions
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 4 , June 2019 , pp. 1401 - 1441
Copyright
Copyright © Cambridge University Press 2017 

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Footnotes

For their suggestions and comments I would like to thank Thorsten Beck, Ata Can Bertay, Harry Huizinga, Manuel Oechslin, Gonzague Vannoorenberghe, Wolf Wagner, and Ping Wang; conference participants at 2012 Midwest Economic Theory Meetings, 2013 Society for Advanced Economic Theory Conference, 2013 Tilburg Development Economics Workshop; and seminar participants at Goethe University and Tilburg University.

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