Financial Intermediation and Aggregate Fluctuations: A Quantative Analysis

This paper investigates the quantitative implications of two business cycle models in which aggregate fluctuations arise in response to variations in the process of financial intermediation. In the first, fundamental shocks in the capital accumulation process lead to fluctuations in the real returns from intermediated investment. For this economy, we find that the correlations produced are not consistent with observations of the U.S. economy. In particular, consumption is not smoother than output, investment is negatively correlated with output, variations in the capital stock are quite large and interest rates are procyclical. In an economy with both intermediation and total factor productivity shocks, the correlations we produce are closer to those observed in the U.S. economy only when the intermediation shock is relatively unimportant. In the second economy, variations in the returns to intermediation are part of a sunspot equilibrium. Fluctuations here are driven by self-fulfilling beliefs by private agents regarding the returns to intermediation as in an economy beset by banking crises. For this non-linear economy, we find that the correlations are closer to those observed but the variability of capital relative to output is still too large.