Increasing domestic financial participation: Implications for business cycles and labor markets

Recent policies in emerging economies (EMEs) have sought to increase the shares of households and firms that participate in the domestic banking system amid the backdrop that, compared to advanced economies (AEs), EMEs have drastically lower shares of both firm and household financial participation. We build a model with extensive margins of firm and household financial participation and equilibrium unemployment to study the impact on EME labor-market and business cycle dynamics of increasing the shares of firm and household financial participation in EMEs to AE levels. We find that a joint increase in household and firm domestic financial participation considerably narrow the differences in some, but not all, business cycle moments between EMEs and AEs. Critically, the impact of increasing only firm or only household participation can differ substantially from the impact of a joint increase. We stress the relevance of the extensive margin of domestic financial participation for labor-market and business cycle dynamics and the fact that promoting a joint increase in the shares of household and firm financial participation in EMEs can lead to smoother cyclical fluctuations, particularly in labor markets. (C) 2020 Elsevier Inc. All rights reserved.