14. Financial intermediaries and their governance INTRODUCTION Recall from Part II that the cost of bartering discourages goods and services from moving to their highest valued uses. And while ‘money’ can economize on these costs, a sound monetary system must continually resist political forces that threaten eﬃciency (for example, those associated with time inconsistency problems). By carefully identifying these inﬂuences, we set the stage for investigating how societies organize their monetary authorities and how these organizational mechanisms relate to levels of wealth and ﬂuctuations therein. Chapter 13 similarly sets the stage for our investigation of how societies organize their ﬁnancial markets, and why success on this margin strongly inﬂuences economic performance. Just as Part II highlights the costs of barter to motivate the importance of money, Chapter 13 highlights the costs of ‘lemons’ adversely selecting themselves into ﬁnancial transactions, or individuals acting in a morally hazardous manner, to motivate the importance of ﬁnancial intermediation and corporate governance. In that chapter, we saw that reducing information asymmetries can expand economic opportunities for both suppliers and demanders of ﬁnancial capital. Strong incentives can thus exist for market participants (suppliers and demanders of loanable funds) to mitigate asymmetries in a cost-eﬀective manner. In the present chapter, we’ll evaluate how the incentive for proximate suppliers to mitigate asymmetries relates to the organization of ﬁnancial intermediaries, and what this incentive implies for the eﬃcacy of ﬁnancial regulation.1 This investigation will show how suppliers can facilitate the productive ﬂow of ﬁnancial...
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