Welfare Losses from Financial Frictions: The Role of Fixed Costs
Ahrang Lee ()
No 1359, 2013 Meeting Papers from Society for Economic Dynamics
Are fixed costs to using financial intermediation quantitatively important in explaining income differences across-countries? I introduce fixed costs into an entrepreneurship model with financial frictions where agents are heterogeneous in their financial assets, entrepreneurial ability and labor productivity. I find that the fraction of agents using financial intermediation substantially decreases as fixed costs increase. Fixed costs as low as 11 per cent of typical year's income lower the intermediated population from almost one to one fifth. Fixed costs also reduce accumulation of capital by 20 per cent as they restrict the intermediated population. Lastly, barriers to financial intermediation play an important role in increasing wealth inequality within an economy and across economies. Aforementioned fixed costs raise the wealth Gini index from 0.78 to 0.92 and reduce income by 10 per cent. That is, the fixed costs alone can explain 10% of income difference between Belgium and Guyana.
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