FINANCIAL-MARKETS, INTERMEDIARIES, AND INTERTEMPORAL SMOOTHING

In an over-lapping generations economy with (incomplete) financial mar kets but no intermediaries, there is underinvestment in safe assets. I n an economy with intermediaries and no financial markets, accumulatin g reserves of safe assets allows returns to be smoothed, nondiversifia ble risk to be eliminated, and an ex ante Pareto improvement compared to the allocation in the market equilibrium to be achieved. In a mixed financial system, however, competition from financial markets constra ins intermediaries so that they perform no better than markets alone.