The Long and Short of Financial Development

Douglas Diamond, Yunzhi Hu and Raghuram Rajan

No 33416, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: By improving the pledgeability of returns to financiers, financial development enhances a producer’s ability to raise capital to fund long term complex investments. Consequently, it should increase output and welfare. However, a general equilibrium analysis suggests this is not always so. We consider an economy where producers and consuming/financing households are distinct agents, where producers lack sufficient capital, and where households care about both pledgeable returns and liquidity. In this economy, the greater pledgeability of long-term project earnings can reduce long term production and overall welfare, even though it makes financing more accessible. Our results have implications for why economies face impediments to financial development and overall growth, especially when producer capital is scarce.

JEL-codes: G1 G3 O10 O16 O4 O43 (search for similar items in EconPapers)
Date: 2025-01
New Economics Papers: this item is included in nep-cfn, nep-fdg and nep-inv
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