Intermediation and growth

This dissertation examines the impact of intermediation upon economic and financial development and on market structure. In chapter one, we study financial intermediation under the assumption of costly state verification. A theory of market formation is developed by assuming costly stochastic linkage to debt markets. New results are derived on the relation between economic growth and the debt to equity ratio, the spread between borrowing and lending rates, the return on savings and equity, and inequality. We find that economic growth creates a rate of return disparity that provides incentives for financial development. Financial development, in turn, improves the efficiency of intermediation and raises the rate of growth. Empirical evidence shows that the interest rate spread is positively related to the debt to equity ratio, and that there is a negative correlation between the debt to equity ratio and economic growth. In chapter two, by allowing for the existence of competitive intermediation in a search theoretic model of production and trade, we generate multiple equilibria, characterized by their degree of intermediation, using the assumption of a thick market externality. We find that the existence and optimality of equilibria depend upon the costs of intermediation relative to output. Steady state determination is driven by self-fulfilling expectations. In such instances, government policy can improve social welfare by reducing the rewards to inefficient entrepreneurial activities