Skip to main content

Communication Costs, the Banking System, and Aggregate Activity

Working Paper 405 | Published September 1, 1988

Download PDF


Communication Costs, the Banking System, and Aggregate Activity


A model is constructed where banks provide access to a communication technology which facilitates trade. Bank liabilities may coexist with alternative means of payment in equilibrium, and there exist regions of the parameter space where banking dominates the payments system and where physical exchange media dominate. The model is consistent with some observations concerning the role of the banking system in economic development, and with characteristics of banking crises. In particular, in early stages of economic development: 1) rapid output growth is accompanied by an increasing share of banking in transactions activity and 2) there are recurrent banking "panics" where reductions in measured aggregate output coincide with increases in the use of alternative means of payment relative to bank liabilities. In later stages of development, growth slackens off, the share of banking in the payments system stabilizes and the economy is less likely to be subject to banking panics.

Prepared for a conference on "Models of Money and Intermediation," University of Western Ontario, October 1988. A preliminary version was presented at the NBER Summer Institute, July 1988.