Motivation for the Research
In many service industries, measuring real output is a challenge because it is difficult to measure quality-adjusted prices. The financial services industry lacks even an agreed-upon conceptual basis for measuring nominal, let alone real, output. Conceptually, the most vexing measurement issue arises because banks and other financial service providers often do not charge explicit fees for services, but rather incorporate the charges into an interest rate margin-the spread between the interest rates they charge and pay.
In this paper, the authors address the lack of an agreed-upon conceptual basis for measuring bank output and propose resolutions of some major long-standing debates on this issue.
The authors develop and analyze an optimizing model with financial intermediaries that provide financial services to resolve asymmetric information between borrowers and lenders. These intermediaries are embedded in a dynamic, stochastic, general-equilibrium model in which assets are priced competitively according to their systematic risk, as in the standard consumption capitalasset- pricing model.
The model yields one overarching principle for measuring bank output: Focus on the flow of actual services provided by banks. This principle applies equally to measuring nominal and real banking output-and, by implication, to measuring the implicit price deflator for financial services.
The model, and its implied measure of bank output, can be readily applied to valuing implicit services by financial institutions other than banks, such as insurance companies. The general principle is the same: Apply asset pricing theories to price the financial instrument by itself; the difference between that value and the security's actual value yields the nominal value of the implicit services.
More generally, the authors advocate a model-based approach to measurement for conceptually challenging areas of financial services.