Essays on Financial Frictions and Long-run Economic Performance


Student thesis: Doctoral Thesis

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  • Xi SHI

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Awarding Institution
Award date26 Jan 2016


This thesis studies long-run growth and welfare effects of financial frictions. In particular, two typical types of financial frictions are discussed in this thesis.

One type is the cash-in-advance constraint, which can be thought as arising from the lack of alternative financial means of payment, such as credit, to overcome trading frictions. Based on Stockman (1981), the current thesis examines long-run impacts of the generalized cash-in-advance constraints applied to both consumption and investment purchases. It shows that in the original Stockman-type setup, distortional effects on output and welfare of the CIA constraint applied to consumption are absent, while in an augmented model with labor-leisure choice that, under certain conditions, tighter cash-in-advance constraints applied to both consumption and investment affect output and welfare negatively. The study also examines effects of the CIA constraints on growth by modifying the above models to incorporate endogenous growth. Predictions of the augmented models with labor-leisure choice regarding the GDP level effect and GDP growth effect are further shown to be consistent with the OLS results using a cross-country sample of broad proxies for measuring cash-in-advance constraints. Moreover, the empirical results suggest that relaxing CIA constraints on investment is more effective in generating higher output and growth, which is also a potential implication of the augmented models. Because in the augmented models, CIA constraints on consumption affect the economy only through affecting the employment, while CIA constraints on investment affect the economy not only through the employment, but also through affecting capital accumulation per labor unit.

The other type of financial frictions this thesis considers is the borrowing constraint. In contrast to the existing literatures, it examines two liquidity borrowing constraints, on both consumption and human capital investment, simultaneously in a model. It is shown that if the elasticity of educational expenditure in producing human capital is sufficiently large, when both constraints are binding, the relationship between the education borrowing constraint parameter and long-run growth has an inverted-U shape whereas relaxing borrowing constraints on consumption always shifts the inverted-U shaped line down. Thus appropriate financial repression on educational investment and consumption induces higher growth. Interactive impacts on growth of the two constraints are also discussed: for different tightness of consumption borrowing constraints, a relaxation of the education borrowing constraint may have opposite effects on growth: if consumption borrowing constraints are relatively tight, a relaxation of the education borrowing constraint may induce higher growth; if consumption borrowing constraints are relatively loose, a relaxation of the education borrowing constraint may result in lower growth. Moreover, this study explores welfare effects of the constraints for a particular generation and for a social planner respectively, and shows that simultaneous, appropriate financial repression on education and consumption borrowing can also promote welfare due to externalities from the general equilibrium factor price changes.

    Research areas

  • financial friction, cash-in-advance constraint, borrowing constraint, long-run growth, steady state welfare