Costs and Benefits of the Financial Sector

Marc Teignier, Francisco Rivadeneyra and Tiago Pinheiro
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Tiago Pinheiro: Norwegian School of Economics

No 1295, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: The financial sector allows a better allocation of capital compared to autarchy, increasing the aggregate technology and thus the income growth rate of the economy. At the same time, however, it also amplifies the business cycles through the financial accelerator which increases the volatility of income. In this paper we first present a general equilibrium model which captures both effects of the financial sector. We then parametrize the model to analyze the quantitative effects of policies aimed at reducing the income volatility caused by the financial system. Finally, we study whether limiting the size of the financial sector is welfare enhancing in the context of this model.

Date: 2011
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