nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2009‒03‒14
fifteen papers chosen by
Iulia Igescu
Global Insight, GmbH

  1. Financial Globalization and Economic Policies By Kose, M. Ayhan; Prasad, Eswar; Rogoff, Kenneth; Wei, Shang-Jin
  2. The Aftermath of Financial Crises By Reinhart, Carmen; Rogoff, Kenneth
  3. The Influence of Culture on Economic Outcomes: An Exploration of Islamic Finance as a New Transmission Channel By Laurent Gheeraert
  4. Are Net FDI Flows and Reversals of Capital Flows a Result of Output Growth? By Gilad Aharonovitz; James Miller
  5. Tourism and Economic Growth in Latin American Countries(LAC): Further Empirical Evidence. By Bichaka Fayissa; Christian Nsiah; Badassa Tadasse
  6. Fiscal Convergence, Business Cycle Volatility and Growth By Davide Furceri
  7. Restructuring the Financial System By Philip Brock
  8. The New Global Crisis Makers: Economic Intervention and the Loss of Strategic Leadership By Graeme Donald Snooks
  9. The Misfortune of Non-financial Firms in a Financial Crisis: Disentangling Finance and Demand Shocks By Tong, Hui; Wei, Shang-Jin
  10. Transforming natural resource wealth into sustained growth and poverty reduction : a conceptual framework for Sub-Saharan African oil exporting countries By Toto Same, Achille
  11. "Time to Bail Out-- Alternatives to the Bush-Paulson Plan" By Dimitri B. Papadimitriou; L. Randall Wray
  12. The Universal Shape of Economic Recession and Recovery after a Shock By Challet, Damien; Solomon, Sorin; Yaari, Gur
  13. On the transition dynamics in endogenous recombinant growth models. By Privileggi, Fabio
  14. Does fast Growth in India and China harm U.S. Workers? Insights from Simulation Evidence By Alex Izurieta; Ajit Singh
  15. New Keynesian versus Old Keynesian Government Spending Multipliers By John F. Cogan; Tobias Cwik; John B. Taylor; Volker Wieland

  1. By: Kose, M. Ayhan (International Monetary Fund); Prasad, Eswar (Cornell University); Rogoff, Kenneth (Harvard University); Wei, Shang-Jin (Columbia University)
    Abstract: We review the large literature on various economic policies that could help developing economies effectively manage the process of financial globalization. Our central findings indicate that policies promoting financial sector development, institutional quality and trade openness appear to help developing countries derive the benefits of globalization. Similarly, sound macroeconomic policies are an important prerequisite for ensuring that financial integration is beneficial. However, our analysis also suggests that the relationship between financial integration and economic policies is a complex one and that there are unavoidable tensions inherent in evaluating the risks and benefits associated with financial globalization. In light of these tensions, structural and macroeconomic policies often need to be tailored to take into account country specific circumstances to improve the risk-benefit tradeoffs of financial integration. Ultimately, it is essential to see financial integration not just as an isolated policy goal but as part of a broader package of reforms and supportive macroeconomic policies.
    Keywords: emerging markets, capital flows, capital account liberalization, financial globalization
    JEL: F02 F21 F36 F4
    Date: 2009–02
  2. By: Reinhart, Carmen; Rogoff, Kenneth
    Abstract: This paper examines the depth and duration of the slump that invariably follows severe financial crises, which tend to be protracted affairs. We find that asset market collapses are deep and prolonged. On a peak-to-trough basis, real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Not surprisingly, banking crises are associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls an average of over 9 percent, although the duration of the downturn is considerably shorter than for unemployment. The real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes. The main cause of debt explosions is usually not the widely cited costs of bailing out and recapitalizing the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis. Our estimates of the rise in government debt are likely to be conservative, as these do not include increases in government guarantees, which also expand briskly during these episodes.
    Keywords: duration; financial crisies; real estate; unemployment
    JEL: E44 F30 N20
    Date: 2009–03
  3. By: Laurent Gheeraert (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussels.)
    Abstract: Islamic finance is one of the most prominent phenomena over the last decade in the banking industry in the Middle-East and South-East Asia. It has recently spread in non-Muslim countries, such as the UK or the US. Globally, assets on the books of Shariah-compliant commercial banks have exceeded 350 Billion USD in 2005 and grown by an average of 29% annually from 2000. In spite of the substantial size and growth of this segment, the role of Islamic banking in the economy is still heavily debated and very few empirical work is available. This paper studies the impact of Islamic banking on financial sector development. It circumvents the lack of data through a newly-constructed and comprehensive database, “IFIRST”, covering Islamic commercial banks worldwide over the period 2000-2005. This database is, to our knowledge, unique in the industry. After controlling for standard determinants and potential endogeneity, using religion as an instrument, we find strong and significant empirical evidence of a positive role of Islamic banking on countries’ financial sector development, as measured by private credit over GDP.
    Keywords: culture, religion, Islamic Finance, financial sector development, growth.
    Date: 2008–03
  4. By: Gilad Aharonovitz; James Miller (School of Economic Sciences, Washington State University)
    Abstract: Literature notes many factors as affecting capital flows, but the effects of these flows over the recipient economies and the overall effect over growth are highly debatable. This study claims that although capital flows may be required for the increase in output, other forces are causing this growth and creating the demand for capital. We construct a model in which growth requires both training of managers by firms in order to expand, representing the absorption capacity of the firms, and capital for the firms’ expansion. The model shows that in early stages of development, when output is low, capital inflows are increasing with an increase in the output, but are not the cause for the output growth. However, when output is higher, an increase in the output is associated with financial outflows, since the local savings are increasing by more than the local demand for capital. We test this relationship in a large sample of countries, and manage to explain half of the variations in net FDI flows per capita using the stage of development.
    Keywords: capital flows, reversals, FDI, economic development, firms, growth, on-the-job training
    JEL: F21 O41 O16 F43 J24
    Date: 2008–12
  5. By: Bichaka Fayissa; Christian Nsiah; Badassa Tadasse
    Abstract: From 1995-2007, worldwide tourist arrivals increased about 68.2 percent (or an average annual growth rate of about 5.2 percent) from 534 million to 898 million (UNWTO, 2008). Over the same period, Latin America countries (Central and South America) have experienced a rise in tourist arrivals from 14.3 million to 27.9 million (about 49 % growth) and tourist receipts growth from $2.3 billion to $3.7 billion (about 61 % growth), respectively. The tourism industry in Latin American countries (LAC) has also experienced a sizable increase in annual market share growth rate of 8.7 percent in 2004. Despite this fact, there are only few empirical studies that investigate the contributions of tourism to economic growth and development for Latin American economies. Using a panel data of 17 Latin American countries for the years that span from 1995 to 2004, this study investigates the impact of the tourism industry on the economic growth and development Latin American countries within the framework of the conventional neoclassical growth model. The empirical results show that revenues from the tourism industry positively contribute to both the current level of gross domestic product and the economic growth of LACs as do investments in physical and human capital. Our findings imply that Latin American economies may enhance their economic growth by strategically strengthening the tourism industry while not neglecting the other sectors which also promote growth.
    Keywords: Tourism, Economic Growth, Latin American Countries, Dynamic Panel Data, Fixed Effects, Random Effects, Arellano-Bond Models
    JEL: C33 F14 L83 O40 O54
    Date: 2009–03
  6. By: Davide Furceri
    Abstract: This paper analyzes the effects of fiscal convergence on business cycle volatility and growth. Using a panel 21 OECD countries (including 11 EMU countries) and 40 years of data, we find that countries with similar government budget positions tend to have smoother business cycles. That is, fiscal convergence (in the form of persistently similar ratios of government surplus/deficit to GDP) is systematically associated with smoother business cycles. We also find evidence that reduced business cycle volatility through higher fiscal convergence stimulates growth. Our empirical results are economically and statistically significant and robust.<P>Convergence budgétaire, volatilité des cycles économiques et croissance<BR>Ce document analyse les effets de la convergence budgétaire sur la volatilité des cycles économiques et la croissance. En utilisant un échantillon de 21 pays de l’OCDE (incluant 11 pays de la zone euro) sur 40 ans, nous trouvons que les pays qui ont des positions budgétaires similaires tendent à avoir des cycles plus lisses. Cela signifie que la convergence budgétaire (sous la forme de ratios de déficit en point de PIB constamment similaires) est systématiquement associée à des cycles économiques plus lisses. Nous trouvons également qu’une volatilité des cycles économiques réduite grâce à une convergence budgétaire stimule la croissance. Nos résultats empiriques sont économiquement et statistiquement significatifs et robustes.
    Keywords: croissance économique, economic growth, business cycle volatility, volatilité des cycles économiques, fiscal convergence, convergence budgétaire
    JEL: E44 G20 G21 G28 R21
    Date: 2009–02–25
  7. By: Philip Brock
    Date: 2009–03
  8. By: Graeme Donald Snooks
    Abstract: The “crisis exaggerators” are telling us that current economic conditions amount to an “unprecedented” global economic recession. This is historically incorrect. What is unprecedented is the degree to which economic commentators and political leaders are talking up economic downturn. What is their agenda? Could it be an attempt to prepare the way for an “unprecedented” degree of government intervention in the economy? The “new interventionists” – some of whom, like Kevin Rudd, are now calling themselves “social democrats” – have attacked neoliberalism – the prevailing philosophy of Western governments over the past three decades – for failing to provide the direction and regulation needed to prevent the emergence of global financial crisis. But this misses the real point. Neoliberal governments have in fact been dangerously interventionist. Owing to the inflation-targeting policies they have championed, the dynamic mechanism of modern society has been disrupted, economic growth has slowed dramatically, and unemployment has risen – just as I warned in The Global Crisis Makers in 2000. The new global crisis makers are these new interventionists, who, ironically, not only accept neoliberal policies of inflation targeting but also intend to launch massive Keynesian and climate-mitigation programmes of intervention that will throw our strategic life-system into a downward spiral from which we will recover only with great difficulty and cost. Modern governments have lost the age-old art of strategic leadership, which once facilitated the effective operation of humanity’s dynamic life-system.
    Keywords: global crisis, neoliberalism, social democracy, strategic leadership, economic intervention
    JEL: O11 O47 O56 E31 E32 E42 E50 E60
    Date: 2009–02
  9. By: Tong, Hui; Wei, Shang-Jin
    Abstract: If a non-financial firm does not do well in a financial crisis, it could be due to either a contraction of demand for its output or a contraction of supply of external finance. We propose a framework to assess the relative importance of the two shocks, making use of a measure of a firm's financial constraint based on Whited and Wu (2006) and another measure of sensitivity to a demand shock, and apply it to the 2007-2008 crisis. We find robust evidence suggesting that both channels are at work, but that a finance shock is economically more important in understanding the plight of non-financial firms.
    Keywords: demand shock; financial crisis; liquidity constraint
    JEL: G2 G3
    Date: 2009–03
  10. By: Toto Same, Achille
    Abstract: Oil and mineral revenues raise national savings and hence facilitate investment, capital accumulation, and sustained growth; thus, there are benefits of owning large natural resources. There can be a significant spillover effect from the oil sector to the non-oil sector particularly if governments are committed to bridge the infrastructure gap and promote the non-oil economy and foremost the non-oil tradable sector. Consequently, the capacity for coordinated policy formulation and execution is fundamental as well as sound windfall management mechanisms and institutions. This conceptual framework uses the case of Indonesia and the example of Norway to argue that the resource paradox is avoidable. Abundance should not be a curse, but rather a blessing for Sub-Saharan Africa's oil and mineral exporting countries. The country context and political economy matter a great deal but should not be the main driving forces behind windfall management, to avoid excessive rent-seeking activities, inefficiency, and wasteful spending. The EITI++ implementation can contribute to make a difference, mostly through capacity building, implementation assistance, and coordination support.
    Keywords: Economic Theory&Research,Debt Markets,Currencies and Exchange Rates,,Access to Finance
    Date: 2009–03–01
  11. By: Dimitri B. Papadimitriou; L. Randall Wray
    Abstract: While serving as chairman of the Federal Reserve Board, Alan Greenspan advocated unsupervised securitization, subprime lending, option ARMs, credit-default swaps, and all manner of financial alchemy in the belief that markets "work" to reduce and spread risk, and to allocate it to those best able to assess and bear it--in his view, markets would stabilize in the absence of nasty government intervention. But as Greenspan now admits, he could never have imagined the outcome: a financial and economic crisis of biblical proportions. The problem is, market forces are not stabilizing. Left to their own devices, Wall Street wizards gleefully ran right off the cliff, and took the rest of us with them for good measure. The natural instability of market processes was recognized long ago by John Maynard Keynes, and convincingly updated by Hyman P. Minsky throughout his career. Minsky's theory explained the transformation of the economy over the postwar period from robust to fragile. He pointed his finger at managed money--huge pools of pension funds, hedge funds, sovereign wealth funds, university endowments, money market funds--that are outside traditional banking and therefore largely underregulated and undersupervised. With a large appetite for risk, managed money sought high returns promised by Wall Street's financial engineers, who innovated highly complex instruments that few people understood. In this new Policy Note, President Dimitri B. Papadimitriou and Research Scholar L. Randall Wray take a look back at Wall Street's path to Armageddon, and propose some alternatives to the Bush-Paulson plan to "bail out" both the Street and the American homeowner. Under the existing plan, Treasury would become an owner of troubled financial institutions in exchange for a capital injection--but without exercising any ownership rights, such as replacing the management that created the mess. The bailout would be used as an opportunity to consolidate control of the nation's financial system in the hands of a few large (Wall Street) banks, with government funds subsidizing purchases of troubled banks by "healthy" ones. But it is highly unlikely that relieving banks of some of their bad assets, or injecting some equity into them, will increase their willingness to lend. Resolving the liquidity crisis is the best strategy, the authors say, and keeping small-to-medium-size banks open is the best way to ensure access to credit once the economy recovers. A temporary suspension of the collection of payroll taxes would put more income into the hands of households while lowering the employment costs for firms, fueling spending and employment. The government should assume a more active role in helping homeowners saddled with mortgage debt they cannot afford, providing low-cost 30-year loans directly to all comers; in the meantime, a moratorium on foreclosures is necessary. And federal grants to support local spending on needed projects would go a long way toward rectifying our $1.6 trillion public infrastructure deficit. Can the Treasury afford all these measures? The answer, the authors say, is yes--and it is a bargain if one considers the cost of not doing it. It is obvious that there exist unused resources today, as unemployment rises and factories are idled due to lack of demand. Markets are also voting with their dollars for more Treasury debt. This does not mean the Treasury should spend without restraint--whatever rescue plan is adopted should be well planned and targeted, and of the proper size. The point is that setting arbitrary budget constraints is neither necessary nor desired--especially in the worst financial and economic crisis since the Great Depression.
    Date: 2008–11
  12. By: Challet, Damien; Solomon, Sorin; Yaari, Gur
    Abstract: We show that a simple and intuitive three-parameter equation fits remarkably well the evolution of the gross domestic product (GDP) in current and constant dollars of many countries during the times of recession and recovery. We then argue that it can be used to detect shocks and discuss its predictive power. Finally, a two-sector theoretical model of recession and recovery illustrates how the severity and length of recession depends on the dynamics of transfer rate between the growing and failing parts of the economy.
    Keywords: Economic growth, transition economies, GDP, modelling, prediction, optimal policy
    JEL: C32 O23 O41
    Date: 2009
  13. By: Privileggi, Fabio
    Abstract: This paper constitutes a first attempt at studying the transition dynamics of the Tsur and Zemel (2007) continuous time endogenous growth framework in which knowledge evolves according to the Weitzman (1998) recombinant process. For a specific choice of the probability function characterizing the Weitzman recombinant process, we find a suitable transformation for the state and control variables in the dynamical system diverging to asymptotic constant growth, so that an equivalent 'detrended' system converging to a steady state in the long run can be tackled. Since the dynamical system obtained so far turns out to be analytically intractable, we rely on numerical simulation in order to fully describe the transition dynamics for a set of values of the parameters.
    Keywords: Knowledge Production, Recombinant Expansion Process, Endogenous Balanced Growth, Turnpike, Transition Dynamics
    JEL: C61 O31 O41
    Date: 2008–12
  14. By: Alex Izurieta; Ajit Singh
    Abstract: A major political and policy issue today is whether globalisation and rapid economic growth in India and China would have an adverse affect on labour markets in the U.S. and other advanced countries. Some leading economists have argued that even though the recent integration of India and China with the liberalised global economy has not so far had a serious negative impact on wages and employment in advanced countries, it is most likely to do so in the future in view of the growing technological and scientific capabilities in the two developing countries. This is also because it is suggested that this integration represents a sudden doubling of the world labour force without a concomitant increase in capital. The present paper argues against this plausible thesis, essentially on two grounds: (a) it does not take into account the demand side effects of fast growth in India and China; and (b) it abstracts from the dynamism of the U.S. real economy and its innovative large corporations. However, simulations of different scenarios on the CAM world econometric model indicate that at a disaggregated level there are severe supply side constraints on energy, raw materials and food which thwart the expansionary demand side effects of fast growth in India and China.
    Keywords: Globalisation; China and India; Simulation; U.S. Workers; Economic integration
    JEL: J20 J21 F01
    Date: 2008–12
  15. By: John F. Cogan; Tobias Cwik; John B. Taylor; Volker Wieland
    Abstract: Renewed interest in fiscal policy has increased the use of quantitative models to evaluate policy. Because of modelling uncertainty, it is essential that policy evaluations be robust to alternative assumptions. We find that models currently being used in practice to evaluate fiscal policy stimulus proposals are not robust. Government spending multipliers in an alternative empirically-estimated and widely-cited new Keynesian model are much smaller than in these old Keynesian models; the estimated stimulus is extremely small just when needed most, and GDP and employment effects are only one-sixth as large, with private sector employment impacts likely to be even smaller.
    JEL: C52 E62
    Date: 2009–03

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