What Happens When Intermediation Fails?

Economic growth cannot occur without savings and those savings must be processed and intermediated through banks, bond markets, stock markets, and so on. Countries without these institutions have smaller markets for loans, use their savings less effectively, and make fewer good investments.4 But why do some countries have poorly developed banking and financial systems?

The bridge between savers and borrowers can be broken in many ways, including insecure property rights, inflation and controls on interest rates, politicized lending, and massive bank failures and panics. These problems can break the bridge by (1) reducing the supply of savings, (2) raising the cost of intermediation, and (3) reducing the effectiveness of lending. Figure 9.11 illustrates the main ideas.

Breaking the Bridge

CHECK YOURSELF

Question 9.8

What is the primary role of financial intermediaries?

Question 9.9

If your $1,000 corporate bond pays you $60 in interest every year and the interest rate falls to 4%, does the price of the bond rise or fall? What happens if the interest rate rises to 8%?

Question 9.10

Why does an IPO increase net investment in the economy but your purchase of 200 shares of IBM stock does not increase investment?

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