Monetary Equilibrium and the Cost of Banking Activity

Paola Boel and Gabriele Camera

Journal of Money, Credit and Banking, 2020, vol. 52, issue 4, 653-683

Abstract: We investigate the effects of banks' operating costs on allocations and welfare in a low interest rate environment. We introduce an explicit production function for banks in a microfounded model where banks employ labor resources, hired on a competitive market, to run their operations. In equilibrium, this generates a spread between interest rates on loans and deposits, which reflects the underlying monetary policy and the efficiency of financial intermediation. In a deflation or low‐inflation environment, equilibrium deposits yield zero returns. Hence, banks soak up labor resources to offer deposits that do not outperform idle balances, thus reducing aggregate efficiency.

Date: 2020
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https://doi.org/10.1111/jmcb.12676

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Working Paper: Monetary Equilibrium and the Cost of Banking Activity (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:52:y:2020:i:4:p:653-683

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