nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2019‒11‒18
twelve papers chosen by
Georg Man

  1. Financial development and growth in European regions By Paola Rossi; Diego Scalise
  2. The Change of the Financial System and Developmental State in Korea By Lee, Kang-kook
  4. Capital inflows, sustained investment surges, and the role of external economies of scale in a developing economy. By Arslan Razmi
  5. Financial system heterogeneity and FDI flows: evidence from OECD economies By Konstantinos Dellis
  6. Prudential Regulation of Banks in Less Developed Economies By Murshed, S. Mansoob; Subagjo, Djono
  7. In the face of spillovers: prudential policies in emerging economies By Coman, Andra; Lloyd, Simon
  9. Costly default and asymmetric real business cycles By Patrick Fève; Pablo Garcia Sanchez; Alban Moura; Olivier Pierrard
  10. Estrategias para el uso productivo de remesas familiares e inclusión financiera: estudio de caso de la cadena de tomate y chile verde en El Salvador By Padilla, Ramón; Santamaría, Jesús; Villarreal, Francisco G.
  11. Local crowding out in China By Huang, Yi; Pagano, Marco; Panizza, Ugo
  12. Credit, capital and crises: a GDP-at-Risk approach By Aikman, David; Bridges, Jonathan; Hacioglu Hoke, Sinem; O’Neill, Cian; Raja, Akash

  1. By: Paola Rossi (Banca d'Italia); Diego Scalise
    Abstract: In this paper we study the relationship between financial development and economic growth across European regions, exploiting the within-country variability of our data. First, we collect a number of indicators to capture the financial structure for each of the 110 EU27 regions. Then, the multiplicity of indicators (the number of bank branches, the presence of bank headquarters, the value added by the financial sector and the presence of a stock exchange) is decreased through a principal component analysis to show summary measures capturing the capillarity of bank branches and the agglomeration and complexity of the financial industry at large. In order to establish a causal nexus, we control for country fixed effects and we instrument financial variables. We use two instruments derived from the historical religious affiliations across European regions: the presence of Protestant communities in the 16th century (the Peace of Augsburg in 1555 allocated each region within the Holy Roman Empire to a different faith according the Prince’s religion) and the presence of Jewish communities in the 18th century. Our estimates point to a positive nexus between financial development and economic growth, showing that what matters most is the presence of a complex and diversified financial sector rather than the capillarity of bank branches.
    Keywords: growth, financial development, European Regions
    JEL: O16 E44 R11
    Date: 2019–11
  2. By: Lee, Kang-kook
    Abstract: This study examines the role of institutions and their change related to the rapid economic development and the 1997 Korean financial crisis. In Korea, the government built a state-led financial system through the 1960s and 1970s and a specific government-bank-business relationship based on it. It promoted economic growth by allocating financial resources controlled by it to targeted industries or firms, with discipline over business achieved through these institutions. However, as the economy developed, this financial system and the relationship between the government and business changed. While the government's control of finance weakened, the economic power of chaebols grew stronger, and their relationship changed from dominance and discipline with co-operation to regulation and conflicts. Accordingly, former institutions could not work well, but there was no proper reformulation of them and they failed to evolve to match these changes. The banks failed to monitor business and the problems in banks and chaebols, including the bad corporate governance, grew serious. Subsequently, the rapid and incautious financial liberalization with these problems led the Korean economy into economic crisis in 1997. Institutional reforms and new institution building are urgently required, but must be adopted under adverse circumstances.
    Keywords: International Development
  3. By: Amin, Aloysius Ajab
    Abstract: The paper identifies and examines those factors that have affected growth in the CFA franc zone countries relative to the non CFA countries. It examines the special arrangements between franc zone countries and France, which give some advantages that seem not to have created a more rapid and sustained growth in the CFA franc zone region. However, the most important factor (which seems to reflect other factors) is found to be the institutional rigidity imposed by the monetary and exchange rate arrangement. The rigidities have negatively affected the different aspects of economies of the CFA franc countries, and therefore affect their long-term growth prospects as an examination of the different factors strongly indicates. For example the imbalances, particularly the external imbalances lacked the self-correcting mechanism. Most of the Non-CFA countries depended on external adjustment strategies by relying on the flexible exchange rate adjustment although with high inflation. The CFA franc countries tried to correct the imbalances by internal adjustment alone with much difficulty. A major difficulty is that the export base is mainly primary goods and the one time across-the-board (all countries the same rate) devaluation increase capacity utilization rather than capacity expansion in almost all the countries. Very thin trade within the zone and large trade between the zone and other countries, tend to generate much disequilibrium. Also a strong and unified monetary system has not been able to produce a strong financial and banking system in the zone. The weak banking sector has therefore encouraged capital flight. Hence for effective macro-economic policy for long-term growth, the factors and rigidities analysed in the paper must actually be taken into consideration and in some cases rigidities must be removed.
    Keywords: International Development
  4. By: Arslan Razmi (Department of Economics, University of Massachusetts Amherst)
    Abstract: Standard open economy macro models with unemployment predict a contractionary short-run effect of international capital inflows. Empirical evidence, on the other hand, often associates such inflows with short-term booms, and developing country policy makers frequently go out of their way to welcome foreign capital. Employing a portfolio balance framework, this paper distinguishes between international financial (i.e., bond) and "real" (i.e., equity) flows to explore the different consequences for capital accumulation that may follow over the medium run. The presence of external economies of scale generates multiple equilibria, and different kinds of capital flows may push investment in one direction or the other for sustained periods of time.
    JEL: F21 F32 F43 O11
    Date: 2019
  5. By: Konstantinos Dellis (University of Piraeus – Bank of Greece)
    Abstract: Foreign direct investment (FDI) has grown dramatically as a major form of international capital transfer over the past decades. The unprecedented growth of cross-country FDI flows has been attributed to a rich set of economic, geographical and institutional factors. In this paper we examine the role of financial system heterogeneity as a potential detrimental factor to FDI flows across OECD economies. To do so, we use a panel dataset of the most recently updated bilateral FDI data at the country level according to OECD BMD4 definition and construct measures of financial distance using a broad set of financial indicators. The econometric approach consists of a gravity-style model, estimated according to the latest advancements in econometric techniques in order to avoid omitted variable bias. The results indicate that financial system similarityis associated with increased bilateral FDI flows, a conclusion that is robust across different estimation strategies and financial distance measures. This insightful policy implication for advanced economies is that the restructuring of the financial system and harmonization to best practices can contribute to economic recovery through the FDI channel as well. Finally, the results highlight the importance for the full implementation of the Banking Union and the Capital Markets Union in the EU.
    Keywords: Foreign Direct Investment; Financial Development; Economic Growth; Advanced Economies
    JEL: O43 F21 F38 F65 G20
    Date: 2019–09
  6. By: Murshed, S. Mansoob; Subagjo, Djono
    Abstract: Beginning with an empirical analysis of banking crises using a logit econometric model covering a sample of developed and developing countries between 1980-97, the paper suggests that crises are more likely in years of low growth and high real interest rates. Private sector credit as a percentage of GDP, lagged credit growth and tight liquidity in the banking sector are also strongly related with banking crises. The results call for more robust financial regulation. The paper argues that less developed countries (LDCs) face inherent obstacles in setting up efficient regulation, and building up a sound-banking sector. These are related to the presence of multiple tasks and multiple principals, poor institutions, lack of economies of scales in banking sectors as well as regulatory supervision, and the lack of reputation. LDCs need a regulatory framework that rewards prudent risk taking, but punishes misconduct. This is likely to involve a combination of input based measures impacting on bankers' incentives, with a few direct controls on the output of the banking sector. The paper concludes with a list of policy options whose appropriateness is judged by the 'friendliness' with the circumstances in LDCs.
    Keywords: International Development
  7. By: Coman, Andra (European Central Bank); Lloyd, Simon (Bank of England)
    Abstract: We examine whether emerging market prudential policies offset the macro-financial spillover effects of US monetary policy. We find that emerging markets with tighter overall prudential policy face significantly smaller, and less negative, spillovers to total credit from US monetary policy tightening shocks. Loan-to-value ratio limits and reserve requirements appear to be particularly effective prudential tools at mitigating the spillover effects of US monetary policy. Our findings indicate that prudential policies can dampen emerging markets’ exposure to US monetary policy and the associated global financial cycle, suggesting they may be a useful tool in the face of international macroeconomic policy trade-offs.
    Keywords: International spillovers; local projections; policy interactions; monetary policy; prudential policy
    JEL: E52 E58 E61 F44
    Date: 2019–09–27
  8. By: Nadav Ben Zeev (BGU)
    Keywords: Emerging market economies; Asymmetric Business Cycles; Global risk appetite shocks; Sign-dependent impulse responses
    JEL: F41 F44
    Date: 2019
  9. By: Patrick Fève; Pablo Garcia Sanchez; Alban Moura; Olivier Pierrard
    Abstract: We augment a simple Real Business Cycle model with financial intermediaries that may default on their liabilities and a financial friction generating social costs of default. We provide a closed-form solution for the general equilibrium of the economy under specific assumptions, allowing for analytic results and straightforward simulations. Endogenous default generates asymmetric business cycles and our model replicates both the negative skew of GDP and the positive skew of credit spreads found in US data. Stronger financial frictions cause a rise in asymmetry and amplify the welfare costs of default. A Pigouvian tax on financial intermediation mitigates most of these negative effects at the cost of a steady-state distortion.
    Keywords: Real Business Cycle model, default, financial frictions, asymmetry, skewness
    JEL: E32 E44 G21
    Date: 2019–11
  10. By: Padilla, Ramón; Santamaría, Jesús; Villarreal, Francisco G.
    Abstract: En algunos países de ingreso medio y bajo, los flujos de las remesas superan con amplitud a los que corresponden, por ejemplo, a la inversión extranjera directa y la asistencia oficial para el desarrollo. El Salvador es el país de América Latina en el que estos flujos tienen el mayor peso en el producto interno bruto (PIB). Aunque la mayor parte de las remesas se orienta a satisfacer las necesidades básicas de los hogares receptores, hasta una tercera parte de estas se ahorra o se invierte, principalmente en educación y salud. No obstante, el uso de las remesas familiares para la inversión productiva y el emprendimiento es aún reducido. Algunos de los factores que limitan su inversión en actividades productivas son la fragmentación excesiva de los recursos disponibles, escasas capacidades empresariales, baja rentabilidad de las inversiones locales, desconfianza en la estabilidad macroeconómica, así como la limitada inclusión financiera de los hogares receptores de remesas, situación que se acentúa en el ámbito rural. El objetivo de este documento es presentar un conjunto de estrategias que fomenten un mayor uso productivo de las remesas familiares en El Salvador a través de una mayor inclusión financiera, a partir del estudio de caso de la cadena de valor de tomate y chile verde. Sobre la base del análisis del estado actual de los flujos de remesas y su uso, así como del examen de las principales limitaciones que enfrenta la cadena de valor, se identifican oportunidades para apalancar las remesas familiares en el financiamiento de proyectos productivos mediante un mayor acceso y uso de productos financieros formales y servicios.
    Date: 2019–11–08
  11. By: Huang, Yi; Pagano, Marco; Panizza, Ugo
    Abstract: In China, between 2006 and 2013, local public debt crowded out the investment of private firms by tightening their funding constraints, while leaving state-owned firms' investment unaffected. We establish this result using a purpose-built dataset for Chinese local public debt. Private firms invest less in cities with more public debt, the reduction in investment being larger for firms located farther from banks in other cities or more dependent on external funding. Moreover, in cities where public debt is high, private firms' investment is more sensitive to internal cash flow, also when cash-flow sensitivity is estimated jointly with the probability of being credit-constrained.
    Keywords: investment,local public debt,crowding out,credit constraints,China
    JEL: E22 H63 H74 L60 O16
    Date: 2019
  12. By: Aikman, David (Bank of England); Bridges, Jonathan (Bank of England); Hacioglu Hoke, Sinem (Bank of England and Data Analytics for Finance and Macro (KCL)); O’Neill, Cian (Bank of England); Raja, Akash (Bank of England)
    Abstract: How can macroeconomic tail risks originating from financial vulnerabilities be monitored systematically over time? This question lies at the heart of operationalising the macroprudential policy regimes that have developed around the world in response to the global financial crisis. Using quantile regressions applied to a panel dataset of 16 advanced economies, we examine how downside risk to growth over the medium term, GDP-at-Risk, is affected by a set of macroprudential indicators. We find that credit booms, property price booms and wide current account deficits each pose material downside risks to growth at horizons of three to five years. We find that such downside risks can be partiall y mitigated, however, by increasing the capitalisation of the banking system. We estimate that across our sample of countries, GDP-at-Risk, defined as the 5th quantile of the projected GDP growth distribution over three years, on average deteriorated by around 4.5 percentage points cumulatively in the run-up to the crisis. Our estimates suggest that an increase in bank capital equivalent to a countercyclical capital buffer rate of 2.5% (5%) would have been sufficient to mitigate up to 20% (40%) of this increase in medium-term macroeconomic tail risk.
    Keywords: Financial stability; GDP-at-Risk; macroprudential policy; quantile regressions; local projections
    JEL: G01 G18 G21
    Date: 2019–09–20

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