In an overlapping generations economy with (incomplete) financial markets but no intermediaries, there is underinvestment in safe assets. In an economy with intermediaries and no financial markets, accumulating reserves of safe assets allows returns to be smoothed, nondiversifiable risk to be eliminated, and an ex ante Pareto improvement compared to the allocation in the market equilibrium to be achieved. In a mixed financial system, however, competition from financial markets constrains intermediaries so that they perform no better than markets alone.
ASJC Scopus subject areas
- Economics and Econometrics