nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2018‒08‒20
eight papers chosen by
Georg Man

  1. Financial Development and Economic Growth: A Study for OECD Countries in the Context of Crisis By António Afonso; M. Carmen Blanco-Arana
  2. When losses turn into loans: the cost of undercapitalized banks By Francisca Rebelo; Laura Blattner; Luísa Farinha
  3. An integrated financial amplifier: the role of defaulted loans and occasionally binding constraints in output fluctuations By José R. Maria; Paulo Júlio
  4. A Macroeconomic Model with Financially Constrained Producers and Intermediaries By Vadim Elenev; Tim Landvoigt; Stijn Van Nieuwerburgh
  5. The Macroeconomic Effectiveness of Bank Bail-ins By Katz, Matthijs; van der Kwaak, Christiaan
  6. Firm Investment During Large Crises: The role of Credit Conditions By Alexandros Fakos; Plutarchos Sakellaris; Tiago Tavares
  7. Growth through acquisition of innovations By Galina Besstremyannaya; Richard Dasher; Sergei Golovan
  8. Endogenous monetary approach to optimal inflation-growth nexus in Swaziland By Andrew Phiri

  1. By: António Afonso; M. Carmen Blanco-Arana
    Abstract: We revisit the relationship between economic growth and financial development in OECD countries during the period 1990-2016, paying special attention to the recent economic crisis. Using a random effects model, we find that an increase in domestic credit provided by the financial-sector, in market capitalization and in the turnover ratio of domestic shares entails a significant positive effect on per capita GDP. We also find different effects during the period of the crisis on domestic credit provided by the financial-sector and on market capitalization. Among other socioeconomic determinants related to economic growth, expenditure in education, inflation and unemployment rates appear highly significant for economic growth of the analysed countries.
    Keywords: Financial development, Economic growth, Panel data, Random effects model
    JEL: G0 O1 O47
    Date: 2018–08
  2. By: Francisca Rebelo; Laura Blattner; Luísa Farinha
    Abstract: We provide evidence that a weak banking sector has contributed to low productivity growth following the European sovereign debt crisis. An unexpected increase in capital requirements for a subset of Portuguese banks in 2011 provides a natural experiment to study the effects of reduced bank capital adequacy on productivity. Affected banks respond not only by cutting back on lending but also by reallocating credit to firms in financial distress with prior underreported loan loss provisioning. We develop a method to detect when banks delay loss reporting using detailed loan-level data. We then show that the credit reallocation leads to a reallocation of production factors across firms. A partial equilibrium exercise suggests that the resulting increase in factor misallocation accounts for 20% of the decline in productivity in Portugal in 2012.
    JEL: D24 E51 G21 G38 O47
    Date: 2018
  3. By: José R. Maria; Paulo Júlio
    Abstract: We present a DSGE model for a small euro area economy comprising a banking sector empowered with regulatory capital requirements, defaulted loans and occasionally binding endogenous credit restrictions. Under non-financial shocks no important amplifications arise due to balancing forces: while banks' equity acts as a shock absorber, the observance of regulatory capital requirements acts as a shock amplifier. Under moderately-sized "bad" financial-based shocks defaulted loans increase and banks' value drop. As a result, credit becomes supply constraint for some time, severely amplifying and protracting output downfalls. Endogenous inertia implies a slow recovery in banks' capital and thus an enduring fragility of the banking system. Defaulted loans and credit restrictions are strongly intertwined, since the former severely impact banks' value, hence leveraging the amplification size.
    JEL: E62 F41 H62
    Date: 2018
  4. By: Vadim Elenev; Tim Landvoigt; Stijn Van Nieuwerburgh
    Abstract: How much capital should financial intermediaries hold? We propose a general equilibrium model with a financial sector that makes risky long-term loans to firms, funded by deposits from savers. Government guarantees create a role for bank capital regulation. The model captures the sharp and persistent drop in macro-economic aggregates and credit provision as well as the sharp change in credit spreads observed during the Great Recession. Policies requiring intermediaries to hold more capital reduce financial fragility, reduce the size of the financial and non-financial sectors, and locally increase macro-economic volatility. They redistribute wealth from savers to the owners of banks and non-financial firms. Current capital requirements are close to optimal.
    JEL: E02 E1 E20 E44 E6 G12 G18 G21
    Date: 2018–06
  5. By: Katz, Matthijs; van der Kwaak, Christiaan (Groningen University)
    Abstract: We examine the macroeconomic implications of bailing-in banks? creditors after a systemic financial crisis, whereby bank debt is partially written off. We do so within a RBC model that features an endogenous leverage constraint which limits the size of banks? balance sheets by the amount of bank net worth. Our simulations show that an unanticipated bail-in effectively ameliorates macroeconomic conditions as more net worth relaxes leverage constraints, which allows an expansion of investment. In contrast, an anticipated bail-in will be priced in ex-ante by bank creditors, thereby transferring the bail-in gains from banks to creditors. Therefore the intervention has zero impact on the macroeconomy relative to the no bail-in case. The effectiveness of the bail-in policy can be restored by implementing a temporary tax on debt outflows once creditors start to anticipate a bail-in.
    Date: 2018
  6. By: Alexandros Fakos (ITAM); Plutarchos Sakellaris (Athens University of Economics and Business); Tiago Tavares (CIE ITAM)
    Abstract: Abstract Business fixed investment in Greece collapsed during the Great Depression. In 2014 it was about half the level it attained in 2009. The large crisis was characterized by both a drop in domestic demand and an increase in the shadow cost of capital. In a standand model, firm investment depends on the marginal product of capital which is driven by profitability and on the shadow cost of capital. What was the relative importance of these two factors for the observed investment collapse? Regarding the shadow cost of capital, was its variation mostly due to real investment adjustment costs or frictions in the credit market? To answer these questions, we use a novel, firm-level dataset of Greek manufacturing firms. We find that profitability is not enough to explain observed drop in firm investment. In addition, financing constraints on firm access to capital were the predominant friction from the capital cost side. Our strategy is to estimate a dynamic model of firm investment separately for the periods before and during the crisis. Capital adjustment cost entails both convex and non-convex adjustment costs. We also allow for debt finance subject to collateral constraints, with aggregate financial shocks affecting maximum debt capacity, as in Khan and Thomas (2013). As a first step, we estimate firm profitability and observe extensive heterogeneity both across firms and across sectors before and during the crisis. Intriguingly, while we observe a substantial drop of investment rates in all sectors, in some firm profitability does not drop during the crisis. This is an indication that variation in the cost of capital is important. Our structural estimates show a pronounced increase in the importance of capital adjustment costs during the crisis. A firm model with only real adjustment frictions adequately captures certain data moments like investment rate dispersion and inaction. However, when simulated for the crisis period, conditional on the firm distribution of capital stock and firm profitability, the model can account for less than half the observed drop in the investment rate. In a second step, we augment the model with financial frictions that can generate further variation in the cost of capital across firms. An aggregate financial shock that increases the collateral requirement for borrowing, induces some firms with a good profitability shock realization to reduce investment. Our results highlight the important role of the near collapse of the Greek banking system and extreme tightening of firm financing conditions in generating the collapse in investment during this large crisis.
    Date: 2018
  7. By: Galina Besstremyannaya (Centre for Economic and Financial Research at New Economic School); Richard Dasher (Stanford University); Sergei Golovan (New Economic School)
    Abstract: The paper develops a growth model with acquisition of endogenous innovations. The model builds on the microeconomic evidence about acquisitions in the technology economy: acquirers are innovative firms, which regard acquisitions as a complementary strategy to their R&D investment. Targets are small firms and leaders on the markets for their products. Acquirers are capable of implementing a higher quality improvement of the products of the targets. The model includes the government, which collects corporate profit tax and redistributes it to provide subsidies for innovations and acquisitions. We quantify the model using the 2000-2016 financial data for Japanese firms, matched with their patents. The estimates prove the model's predictions about a positive effect of acquisitions on growth. The impact of acquisitions on the R&D intensity is related to the type of complementarity between innovation and acquisition strategies. The effect of subsidies towards the acquisitions is linked to the parameters of the cost function and reflects the association between the costs of acquisitions and R&D.
    Keywords: innovation, endogenous growth, acquisition, social planner, patents
    JEL: O11 O38 O40 O53
    Date: 2018–08
  8. By: Andrew Phiri (Department of Economics, Nelson Mandela University)
    Abstract: With the inflation-growth nexus being a hotly debated issue within the academic paradigm, the purpose of our study is to examine the relationship for Swaziland between 1975 and 2016 of which there currently exists very limited country-specific evidence. In the design of our study we theoretically depend on an endogenous monetary model of economic growth augmented with a credit technology which causes a nonlinear relationship between inflation and growth. Econometrically, we rely on the smooth transition regression (STR) which allows us to estimate an optimal inflation rate characterized by smooth transition between different inflation regimes. Our empirical results point to an inflation threshold estimate of 7.64% at which economic growth gains are maximized or similarly growth losses are minimized. In particular, we find that above the inflation threshold economic agents may be able to protect themselves from inflation through credit technology and a more urbanized population yet such high inflation adversely affects the influence of exports on economic growth. This noteworthy since a majority of government revenues is from trade activity via the country’s affiliation with the Southern African Customs Union (SACU). Nevertheless, the major contribution of this paper is that it becomes the first to use endogenous growth theory to estimate the inflation threshold for any African country which will hopefully pave a way for similar studies on other African countries.
    Keywords: Inflation, Economic growth, Endogenous monetary growth model, Smooth transition regression, Swaziland, African country.
    JEL: C22 C32 C51 C52 E31 O47
    Date: 2018–07

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