Endogenous market structures in the credit market and Ricardian equivalence

•We analyze endogenous market structures in banking in a dynamic model.•Ricardian equivalence breaks up with imperfect competition in the credit market.•Deficits reduce consumption and increase spreads between deposit and lending rates.

We analyze the impact of imperfect competition in banking on fiscal policy in a dynamic model. In an exchange two-period economy the impact of deficit spending is to reduce private consumption and increase the spread between deposit and lending rates. The reason is that a tax cut forces consumers to save more and makes their supply of savings more rigid, which softens competition between banks leading to lower rates on deposits and a more than proportional increase in savings. In a closed production economy this reduces the equilibrium interest rate on borrowers, which promotes private investment.