Survey_GF_2017

Abstract

More specifically, we develop the result in a simple two-period general equilibrium model in which a fraction of firms have to rely on banks to obtain physical goods. The other firms are financed through the bond market. We consider two different financing architectures of the economy. In both architectures, households decide in the first period on consumption and savings. The latter is split into bank deposits, bank equity, and bonds. Firms obtain loans to undertake production through banks and the bond market, respectively. In the loanable-funds approach, the households’ savings in the form of bank deposits and bank equity are lent to some firms. In the money-creation approach, however, bank lending creates the deposits that are necessary for households to invest in bank deposits and bank equity. We build a general equilibrium model with two periods, one physical good, and two production sectors. Households are initially endowed with the physical good and own the two production sectors. In Period t = 0, households consume a part of the physical good, and the rest is used for production in both sectors. At the start of Period t = 1, the amount of the physical good that is not consumed in Period t = 0 is transformed by the production technologies into a physical good. At the end of Period t = 1, households consume this physical good. After the initial consumption of a share of the physical good at the beginning of the first period, households found banks by exchanging equity contracts against some amount of physical good in the loanable-funds model and by exchanging equity contracts against money in the money-creation model. In one sector, firms can only be financed by bank loans. The other sector is directly financed by households, who provide the firms with the remaining amount of the physical good in exchange for bonds. These bonds represent the agreement that firms will deliver some amount of the physical good after production in the second period against the provision of some amount of the physical good in the first period. In the second period, firms and banks pay dividends from profits to households, who are their shareholders. Limited liability protects the banks’ shareholders, so some banks may fail to repay depositors. Government authorities fully insure the households’ deposits. Banks defaulting against households are bailed out, and government authorities finance the bail-out with lump-sum taxation. In Period t = 0, households consume a part of their endowment of the physical good. They also found banks by providing them with some amount of the physical good in exchange for deposits and equity contracts. Banks then lend this amount of the physical good to firms in one sector. The other sector is directly financed by households, who provide firms in this sector with the remaining amount of the physical good.