Risk Pooling, Intermediation Efficiency, and the Business Cycle

Abstract

We study the relationship between intermediation efficiency and the macroeconomic dynamics within a tractable real business cycle model where: households face restricted market participation; financial intermediaries use leverage to provide costly risk pooling and safe assets. We analytically characterize the general equilibrium effects that associate intermediation costs to the output dynamics and find that a more (less) efficient financial sector can lead to higher (lower) growth, but also amplifies (dampens) output fluctuations. Relatedly, we identify the mechanisms by which the financial sector's impact on growth and its safe assets provision may generate pro- or counter cyclical real risk-free rates.

Keywords: Amplification, business cycle, efficiency, dampening, restricted market participation, risk pooling

JEL Classification: E13, E32, E69, G12