nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2018‒12‒17
ten papers chosen by
Georg Man

  1. Analyzing the Dynamic Relationship between Physical Infrastructure, Financial Development and Economic Growth in India. By Mohanty, Ranjan Kumar; Bhanumurthy, N.R.
  2. A Simple Model of Growth Slowdown By Katsuyuki Shibayama
  3. Collateral Booms and Information Depletion By Asriyan, Vladimir; Laeven, Luc; Martín, Alberto
  4. Financial Deepening, Terms of Trade Shocks, and Growth Volatility in Low-Income Countries By Kangni Kpodar; Maëlan Le Goff; Singh Raju Jan
  5. Does financial sector development affect the growth gains from trade openness? By N.R. Ramírez-Rondán; Marco E. Terrones; Andrea Vilchez
  6. The Term Structure of Growth-at-Risk By Adrian, Tobias; Grinberg, Federico; Liang, Nellie; Malik, Sheherya
  7. Growth divergence and income inequality in OECD countries:the role of trade and financial openness By Enrico D'Elia; Roberta De Santis
  8. The long-run effects of portfolio capital inflow booms in developing countries: permanent structural hangovers after short-term financial euphoria By Botta, Alfredo
  9. Macroeconomic effects of bank capital regulation By Eickmeier, Sandra; Kolb, Benedikt; Prieto, Esteban
  10. Accounting for Macro-Finance Trends: Market Power, Intangibles, and Risk Premia By Emmanuel Farhi; François Gourio

  1. By: Mohanty, Ranjan Kumar (National Institute of Public Finance and Policy); Bhanumurthy, N.R. (National Institute of Public Finance and Policy)
    Abstract: The paper investigates dynamic relationship between physical infrastructure, financial development and economic growth in the case of India, using an Autoregressive Distributed Lag (ARDL) and Toda-Yamamoto (T-Y) causality approach for the period 1980 to 2016. Physical infrastructure index and financial development index are con-structed using Principal Component Analysis method. Empirical results suggest that physical infrastructure has a positive effect on economic growth both in the long-run and short-run, whereas financial development, though significant, has a weak impact on eco-nomic growth. The causality test supports a bi-directional causal relationship between infrastructure development and economic growth, while it finds a unidirectional causa-tion running from economic growth to financial development. It also finds that gross in-vestment and employment have a positive, and inflation has an adverse effect on eco-nomic growth. As India is aiming for higher growth for a sustained period, our results suggest that there is a need for Government intervention in expanding the physical infra-structure and this, in turn, could lead to the growth of the financial sector in the country.
    Keywords: Infrastructure Index ; Financial Development Index ; Economic Growth ; ARDL Approach ; India
    JEL: H40 C43 O40 C32
    Date: 2018–12
  2. By: Katsuyuki Shibayama
    Abstract: This paper studies a simple endogenous growth model to explain growth slowdowns. It is designed to explain, for example, the middle income trap often observed in the south-east Asian countries, the U.K.'s productivity puzzle after the Great Recession and the lost decades of Japan in a unified framework. It is based on the Romer's (1990, JPE) variety expansion model with additional state variable, which we call the R&D environment. The R&D environment is a sort of social capital that captures the research network and culture, society's attitude towards research activities, and so on. Together with the non-negativity constraint of the labour supply, this additional state variable generates multiple steady states (balanced growth paths, BGPs). The model has three BGPs, of which the middle one is unstable (explosive) while the other two satisfy the saddle path stability with high and low R&D activities. Without stochastic shocks, the model exhibits strong initial state dependency, meaning that even only small difference in the initial state could lead to a large difference in the long-run. With stochastic shocks, occasional shifts between two stable BGPs can occur. The model offers an intuitive explanation why a financial shock is particularly important for growth slowdowns. Interestingly, before a growth slowdown, a financial malfunctioning raises the stock return. Finally, our model is fairly realistic in the sense that it allows us to do calibration exercises which are rather standard in the business cycle studies.
    Keywords: endogenous growth; growth slowdown; dynamic stochastic general equilibrium model; middle-income trap; natural resource curse; productivity puzzle; R&D; official development assistance
    JEL: E3 O3 O4
    Date: 2018–11
  3. By: Asriyan, Vladimir; Laeven, Luc; Martín, Alberto
    Abstract: We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US firm-level data in support of the model's main mechanism.
    Keywords: Collateral; Credit Booms; Crises; Information Production; Missallocation
    JEL: D80 E32 E44 G01
    Date: 2018–11
  4. By: Kangni Kpodar (Fonds Monétaire International, FERDI - Fondation pour les Etudes et Recherches sur le Développement International); Maëlan Le Goff (Banque de France - Banque de France - Banque de France); Singh Raju Jan (Banque Mondiale - Banque Mondiale - Banque Mondiale)
    Abstract: This paper contributes to the literature by looking at the possible importance of the structure of the financial system—whether financial intermediation is performed through banks or markets—for macroeconomic volatility, against the backdrop of increased policy attention on strengthening growth resilience. With low income countries (LICs) being the most vulnerable to large and frequent terms of trade shocks, the paper focuses on a sample of 38 LICs over the period 1978-2012 and finds that banking sector development acts as a shock absorber, dampening the transmission of terms of trade shocks to growth volatility. Expanding the sample to 121 developing countries confirms this result, although this role of shock-absorber fades away as economies grow richer. Stock market development, by contrast, appears neither to be a shock absorber nor a shock amplifier for most economies. These findings are robust across fixed effect, System GMM and local projection estimates.
    Keywords: Banks,stock markets,terms of trade,growth volatility
    Date: 2018–10–29
  5. By: N.R. Ramírez-Rondán (Universidad del Pacífico); Marco E. Terrones (Universidad del Pacífico); Andrea Vilchez (Universidad del Pacífico)
    Abstract: A sizeable literature suggests that financial sector development could be an important enabler of the growth benefits of trade openness. We provide a comprehensive analysis of how financial development can affect the relationship between trade openness and growth using a dynamic panel threshold model and an extensive dataset for a large sample of countries for the 1970-2015 period. We find that there is a financial development threshold in which trade openness has a positive and significant effect on economic growth. We also find that when splitting the sample into industrialized and non-industrialized countries, the financial development threshold that enables the growth benefits of trade is higher in the former group of countries than in the latter. This finding is consistent with the fact that the export composition of industrialized countries is tilted towards more capital-intensive finance-constrained goods.
    Keywords: Trade openness, growth, threshold model, panel data
    JEL: F43 O41 C33
    Date: 2018–11
  6. By: Adrian, Tobias; Grinberg, Federico; Liang, Nellie; Malik, Sheherya
    Abstract: Using panel quantile regressions, we show that the conditional distribution of GDP growth depends on financial conditions, with growth-at-risk (GaR)-defined as conditional growth at the lower 5th percentile-more responsive than the median or upper percentiles. The term structure of GaR features an intertemporal tradeoff: GaR is higher in the short run but lower in the medium run when initial financial conditions are loose relative to typical levels. This shift in the growth distribution generally is not incorporated when solving dynamic stochastic general equilibrium models with macrofinancial linkages, which suggests downside risks to GDP growth are systematically underestimated.
    Date: 2018–12
  7. By: Enrico D'Elia; Roberta De Santis
    Abstract: This paper analyzes trade and financial openness effects on growth and income inequality in 35 OECD countries. Our model takes into account both short run and long run effects of factors explaining income divergence between and within the countries. We estimate, for the period 1995-2016, an error correction model in which per capita GDP and inequality are driven by changes over time of selected factors and by the deviation from a long run relationship. Stylised facts suggest that trade and financial openness reduce the growth gaps across the countries but not income inequality, and the effects of finance are stronger in high income countries. Nevertheless, low and middle income countries benefit more from international trade. Our contribution to the existing literature is threefold: i) we study the short and long run effects of trade and financial openness on income level and distribution, ii) we focus on developed countries (OECD) rather than on developing and iii) we provide a sensitivity analysis including in our baseline equation an institutional indicator, a trade agreement proxy and a dummy of global financial crisis. Estimates results indicate that trade openness significantly improved the conditions of OECD low income countries both in short and long run mostly, consistently with the catching up theory. It also decreased inequality, but only in low and middle income countries. Differently financial openness had a positive and significant impact only in the short run on middle income countries and increased income disparities within countries in the short term in low income countries and in the long term in high income countries.
    Keywords: Trade openness, income inequality, panel data analysis
    JEL: D63 D31 H23
    Date: 2018–11
  8. By: Botta, Alfredo
    Abstract: Most of the literature about the effects of portfolio capital inflows to developing countries focuses on how macroeconomic stability is affected. Very little has been said on the long-run consequences that temporary booms in portfolio capital flows may bear by affecting the productive structure, particularly manufacturing development, of developing countries. The present paper tries to partially fill this gap. We first build a simple theoretical model to show how booming portfolio inflows may interact with domestic speculation at home, giving rise to a climate of financial euphoria featuring an appreciating exchange rate and rising prices of domestic speculative assets. We also discuss that such euphoria hardly lasts forever, but rather ends up in a phase of heightened financial turmoil and volatility. As for the long run, we maintain the Kaldorian perspective according to which manufacturing plays a crucial role for the development process of backward economies.
    Date: 2018–12–06
  9. By: Eickmeier, Sandra; Kolb, Benedikt; Prieto, Esteban
    Abstract: Bank capital regulations are intended to enhance financial stability in the long run, but may, in the meanwhile, involve costs for the real economy. To examine these costs we propose a narrative index of aggregate tightenings in regulatory US bank capital requirements from 1979 to 2008. Anticipation effects are explicitly taken into account and found to matter. In response to a tightening in capital requirements, banks temporarily reduce business and real estate lending, which temporarily lowers investment, consumption, housing activity and production. A decline in financial and macroeconomic risk helps sustain spending in the medium run. Monetary policy also cushions negative effects of capital requirement tightenings on the economy.
    Keywords: Narrative Approach,Bank Capital Requirements,Local Projections
    JEL: G28 G18 C32 E44
    Date: 2018
  10. By: Emmanuel Farhi; François Gourio
    Abstract: Real risk-free interest rates have trended down over the past 30 years. Puzzlingly in light of this decline, (1) the return on private capital has remained stable or even increased, creating an increasing wedge with safe interest rates; (2) stock market valuation ratios have increased only moderately; (3) investment has been lackluster. We use a simple extension of the neoclassical growth model to diagnose the nexus of forces that jointly accounts for these developments. We find that rising market power, rising unmeasured intangibles, and rising risk premia, play a crucial role, over and above the traditional culprits of increasing savings supply and technological growth slowdown.
    JEL: E0
    Date: 2018–11

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