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Submitted by Maya Eden on
Thanks for this comment. I agree that the problem of "too much financing" seems more relevant in developed economies than in developing ones. However, I think that this mechanism might be highly relevant for thinking about the social returns to financial development in a general equilibrium framework. Many studies look at micro-interventions and suggest strikingly high returns to financing in developing countries. The general equilibrium model suggests that this type of exercise overstates the returns to finance, as it essentially holds prices fixed. In environments in which funding is highly scarce, the demand for inputs is constrained so equilibrium prices are depressed. Consequently, people who are lucky enough to receive financing can go a long way with a few rupees. However, once access to finance increases on an aggregate level, we should expect input prices to rise, which would result in much more modest returns to financing. Whether or not there are positive returns to increasing access to finance on a large scale remains an open question, especially given the high costs associated with overcoming the various "frictions" you mention.