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Endogenous Financial Friction and Growth

Author

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  • Jeong Minhyeon

    (65770 Korea Institute for International Economic Policy , Sejong, South Korea)

Abstract

Financial frictions have been considered a crucial factor in explaining growth disparities across countries. These frictions are typically viewed as an exogenous constraint on borrowing capacity that is assumed to be invariant to economic conditions, such as the level of GDP and business cycle fluctuations. However, assuming the exogenous constraint on borrowing often leads to unrealistic dynamics in macroeconomic variables, such as constant investment-to-GDP and loan-to-value ratios. Motivated by these limitations, we develop a growth model in which the severity of the borrowing constraint is endogenously determined. The borrowing constraint adversely affects growth and amplifies the negative effect of volatility on growth. However, these growth effects gradually disappear as the economy continues to grow, because debtors become more willing to honor their debts along with economic growth, resulting in an endogenous relaxation of the borrowing constraint.

Suggested Citation

  • Jeong Minhyeon, 2024. "Endogenous Financial Friction and Growth," The B.E. Journal of Macroeconomics, De Gruyter, vol. 24(2), pages 677-713.
    • Handle: RePEc:bpj:bejmac:v:24:y:2024:i:2:p:677-713:n:1008
    DOI: 10.1515/bejm-2024-0028
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    More about this item

    Keywords

    financial friction; growth; volatility;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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