Endogenous Financial Friction and Growth

Jeong Minhyeon ()
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Jeong Minhyeon: 65770 Korea Institute for International Economic Policy , Sejong, South Korea

The B.E. Journal of Macroeconomics, 2024, vol. 24, issue 2, 677-713

Abstract: Financial frictions have been considered a crucial factor in explaining growth disparities across countries. These frictions are typically viewed as an exogenous constraint on borrowing capacity that is assumed to be invariant to economic conditions, such as the level of GDP and business cycle fluctuations. However, assuming the exogenous constraint on borrowing often leads to unrealistic dynamics in macroeconomic variables, such as constant investment-to-GDP and loan-to-value ratios. Motivated by these limitations, we develop a growth model in which the severity of the borrowing constraint is endogenously determined. The borrowing constraint adversely affects growth and amplifies the negative effect of volatility on growth. However, these growth effects gradually disappear as the economy continues to grow, because debtors become more willing to honor their debts along with economic growth, resulting in an endogenous relaxation of the borrowing constraint.

Keywords: financial friction; growth; volatility (search for similar items in EconPapers)
JEL-codes: E22 O16 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1515/bejm-2024-0028

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