Working Paper 685

Costly Financial Intermediation in Neoclassical Growth Theory

Edward C. Prescott - Senior Monetary Advisor
Rajnish Mehra
Facundo Piguillem

Published April 4, 2011

The neoclassical growth model is extended to include costly intermediated borrowing and lending between households. This is an important extension as substantial resources are used in intermediating the large amount of borrowing and lending between households. In 2007, in the United States, the amount intermediated was 1.7 times GNP, and the resources used in this intermediation amounted to at least 3.4 percent of GNP. The theory implies that financial intermediation services are an intermediate good and that the spread between borrowing and lending rates measures the efficiency of the financial sector.

This paper was previously published as Working Paper 655 and Staff Report 405 under the title "Intermediated Quantities and Returns."

Published In: Quantative Economics (Vol. 2, No. 1, March 2011, pp. 1-36)

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