Quantitative Economics: Mar, 2022, Volume 2, Issue 1

Costly financial intermediation in neoclassical growth theory

Rajnish Mehra, Facundo Piguillem, Edward C. Prescott

The neoclassical growth model is extended to include costly intermediated bor-
rowing and lending between households. This is an important extension as sub-
stantial resources are used to intermediate the large amount of borrowing and
lending between households. In 2007, in the United States, the amount interme-
diated was 1.7 times gross national product (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 sec-
tor.
Keywords. Aggregate intermediation, borrowing, lending, equity premium, gov-
ernment debt, life cycle savings, retirement.
JEL classification. D31, E2, E21, E44, G1, G11, G12, G23, H0, H62.

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