28 , 2015-06 , Graduate School of Economics and Osaka School of International Public Policy (OSIPP) Osaka University
This study introduces financial intermediaries into the Schumpeterian growth model developed by Aghion, Howitt, and Mayer-Foulkes (2005). They collect deposits from households, provide funds for entrepreneurial projects, and monitor the entrepreneurs. I consider an economy with moral hazard problems: entrepreneurs can hide the result of a successful innovation and thereby avoid repaying financial intermediaries if the latter do not monitor entrepreneurial performance. I analyze the effects of financial intermediaries’ activities on technological progress and economic growth in such an economy. I show that financial intermediaries need to monitor entrepreneurs in an economy where the legal protection of creditors is not strong enough. Such monitoring can resolve the moral hazard problem; however, it does not always promote technological innovation, because it could increase the cost of entrepreneurial innovation and thus reduce the amount invested for innovation. I also examine how monitoring by financial intermediaries affects the welfare of individuals through the stringency of financial markets.