The role of internal financing in a Ramsey model with financial intermediation

Karl-Heinz Tödter

Applied Financial Economics Letters, 2006, vol. 2, issue 5, 295-299

Abstract: This note integrates internal financing, costly financial intermediation, and interest on household savings into a Ramsey model, extending the approach of Bhattarai (2005) in several respects. The study finds that the cost of financial intermediation creates a welfare loss, even under the assumption of perfect competition in the financial sector, i.e. when the spread between credit and deposit rates vanishes. Restoring the efficient equilibrium requires both, perfect competition and internal financing of replacement investment.

Date: 2006
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DOI: 10.1080/17446540600690144

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