Macroeconomic Dynamics

Articles

MEASURING THE IMPACT OF FINANCIAL INTERMEDIATION: LINKING CONTRACT THEORY TO ECONOMETRIC POLICY EVALUATION

Robert M. Townsenda1 c1 and Sergio S. Urzuaa2

a1 Massachusetts Institute of Technology

a2 Northwestern University

Abstract

We study the impact that financial intermediation can have on productivity through the alleviation of credit constraints in occupation choice and/or an improved allocation of risk, using both static and dynamic structural models as well as reduced-form OLS and IV regressions. Our goal in this paper is to bring these two strands of the literature together. Even though, under certain assumptions, IV regressions can accurately recover the true model-generated local average treatment effect, this is quantitatively different, in order of magnitude and even sign, from other policy impact parameters (e.g., ATE and TT). We also show that laying out clearly alternative models can guide the search for instruments. On the other hand, adding more margins of decision, that is, occupation choice and intermediation jointly, or adding more periods with promised utilities as key state variables, as in optimal multiperiod contracts, can cause the misinterpretation of IV as the causal effect of interest.

Keywords:

  • Contract Theory;
  • Financial Intermediation;
  • Econometric Policy Evaluation

Correspondence:

c1 Address correspondence to: Robert M. Townsend, Elizabeth and James Killian Professor of Economics at MIT and Research Associate at the University of Chicago, 50 Memorial Drive, Cambridge, MA 02142, USA; e-mail: rtownsen@mit.edu.

Footnotes

Research funding from NICHD, NFS, Templeton Foundation, and the Bill and Melinda Gates Foundation to the University of Chicago is gratefully acknowledged. The views expressed in this paper are those of the authors and not necessarily those of the funders listed here. We have received helpful comments from Cynthia Kinnan, Benjamin Olken, Marti Mestieri, and Gabriel Madeira. Gabriel Madeira provided excellent research assistance.

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