Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 331: Money, Credit and Banking and the Cost of Financial Activity

Paola Boel () and Gabriele Camera
Additional contact information
Paola Boel: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Gabriele Camera: Chapman University and University of Basel

Abstract: We extend the study of banking equilibrium in Berentsen, Camera and Waller (2007) by introducing an explicit production function for banks. Banks employ labor resources, hired on a competitive market, to run their operations. In equilibrium this generates a spread between interest rates on loans and on deposits, which naturally reflects the efficiency of financial intermediation and underlying monetary policy. In this augmented model, equilibrium deposits yield zero return in a deflation or very low inflation. Hence, if monetary policy is sufficiently tight then banks end up reducing aggregate efficiency, soaking up labor resources while offering deposits that do not outperform idle balances.

Keywords: banks; frictions; matching

JEL-codes: C70; D40; E30; J30

39 pages, October 1, 2016

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