Costly Financial Intermediation and Excess Consumption Volatility

This paper documents the cyclical properties of financial intermediation costs and uses their dynamics to explain excess consumption volatility differences across countries in a dynamic stochastic general equilibrium (DSGE) framework. I find that financial development levels have no role in explaining excess consumption volatilities. Instead, the volatility of the financial sector plays the determinative role. The model matches the data, finding excess consumption volatility to be four times higher in an average emerging country compared to the US. This paper also shows that if the US had the same intermediation cost structure as the average emerging country, deteriorations in the production, consumption, labor market, business investment, and real estate market following a financial shock would increase sixfold, on average.