Financial intermediation costs: effects on business cycles, delayed recoveries and relative consumption volatility

Abstract

This dissertation explores a largely ignored phenomenon, financial intermediation costs and their effects on business cycles. By constructing a unique micro level, high frequency dataset that contains intermediation cost breakdowns, this dissertation enables the study of financial intermediation costs in great detail. These costs, as financial shocks, have significant impacts on business cycles by creating large distortions in the economy. In particular, this study highlights the role of intermediation cost in delaying recoveries from recessions and increasing consumption volatility across countries.

This dissertation incorporates costly financial intermediation into two different general equilibrium models. The first model addresses the following empirical facts: (1) Recoveries from recessions take longer when they are initiated by financial crises. (2) The financial sector experiences longer recoveries in lending rates. (3) Business cycle and the lending rate recoveries take longer for emerging countries than their developed counterparts. The second model emphasizes the relationship between housing market interactions and intermediation costs to explain high relative consumption volatility in emerging markets compared to developed countries. This study demonstrates that if the US had the same intermediation cost structure as an average emerging country, negative effects of a financial shock on consumption and output would double and deteriorations in the housing and financial sectors would increase almost tenfold.