nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2023‒04‒10
twenty-two papers chosen by
Georg Man

  1. The Macroeconomics of Trade Credit By Luigi Bocola; Gideon Bornstein
  2. The Impact of Investments on Economic Growth: Evidence from Tajikistan By Mubinzhon, Abduvaliev
  3. Domestic savings in sub-Saharan Africa: The case of Ghana By Charles Godfred Ackah; Monica P. Lambon-Quayefio
  4. Is acquisition-FDI during an economic crisis detrimental for domestic innovation? By Maria Garcia-Vega; Apoorva Gupta; Richard Kneller
  5. Partial Ownership, Financial Constraint, and FDI By ITO Tadashi; Michael RYAN; TANAKA Ayumu
  6. Financial Development and Export Concentration By Florian Unger
  7. Exportweltmeister- Germany's Foreign Investment Returns in International Comparison By Franziska Hunnekes; Maximilian Konradt; Moritz Schularick; Christoph Trebesch; Julian Wingenbach
  8. Imperfect bank competition, borrower adverse selection, and the transmission of monetary policy By Miguel Cantillo
  9. Liquidity Creation and Trust Environment By Jérémie Bertrand; Jean-Loup Soula; Paul-Olivier Klein
  10. Modeling Determinants of Private Banks Profitability in Ethiopia By mohammed, habib
  11. Public Debt and the Balance Sheet of the Private Sector By Gersbach, Hans; Rochet, Jean-Charles; von Thadden, Ernst-Ludwig
  12. The Impact of Public Sector Lending on Financial Stability in Central Africa By Kouam, H; Kouam, S
  13. Time-varying stock return correlation, news shocks, and business cycles By Metiu, Norbert; Prieto, Esteban
  14. Analyzing and forecasting economic crises with an agent-based model of the euro area By Cars Hommes; Sebastian Poledna
  15. Expectation-Driven Boom-Bust Cycles By Brianti, Marco; Cormun, Vito
  16. Optimal Monetary and Macroprudential Policies under Fire-Sale Externalities By Flora Lutz
  17. Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs? By Erica Xuewei Jiang; Gregor Matvos; Tomasz Piskorski; Amit Seru
  18. Know your (holding) limits: CBDC, financial stability and central bank reliance By Barbara Meller; Oscar Soons
  19. The Internationalization of China’s Equity Markets By Mr. Maria Soledad Martinez Peria; Mr. Sergio L. Schmukler; Jasmine Xiao; Juan J. Cortina
  20. Resolving financial distress where property rights are not clearly defined: The case of China By Franks, Julian R.; Miao, Meng; Sussman, Oren
  21. Panda Bond Financing of the Belt & Road Initiative: An Analysis of Monetary Mechanisms and Financial Risks By Alfredo Schclarek; Jiajun Xu
  22. Cryptocurrencies Are Becoming Part of the World Global Financial Market By Marcin W\k{a}torek; Jaros{\l}aw Kwapie\'n; Stanis{\l}aw Dro\.zd\.z

  1. By: Luigi Bocola; Gideon Bornstein
    Abstract: In most countries, suppliers of intermediate goods and services are also the main providers of short-term financing to firms. This paper studies the macroeconomic implications of these financial links. In our model, trade credit is the outcome of a long-term contract between firms linked in the production process, and it is sustained in equilibrium by reputation forces as customers lose the relationship with their suppliers in case of a default. These financial links give rise to a credit multiplier: suppliers can enforce repayment of these IOUs, and they can discount these bills with banks to obtain liquidity. This process can either dampen or amplify the output effects of financial shocks, depending on the borrowing capacity of suppliers. Using Italian data, we find that the credit multiplier is sizable and show that trade credit amplified the output costs of the Great Recession by 45%.
    JEL: E44 G01 G30
    Date: 2023–03
  2. By: Mubinzhon, Abduvaliev
    Abstract: The aim of this paper is to assess the effect of foreign direct investment on economic growth in Tajikistan. Using annual time series data for 2005 to 2021, the study reveals a relationship between foreign direct investment and per capita GDP growth in Tajikistan. Based on the analysis of the Vector Error Correction Model (VECM), it has been found that these variables have a long-term relationship. The residuals of the regressions showed no auto-correlation in the post-estimation diagnostic tests performed to determine the validity of the VECM model. Furthermore, our findings suggest that improving the institutional quality of the country complements the improvement of the investment climate and results in significant increases in foreign direct investment inflows.
    Keywords: foreign direct investments, economic growth, Tajikistan
    JEL: F21
    Date: 2023–03–10
  3. By: Charles Godfred Ackah; Monica P. Lambon-Quayefio
    Abstract: One essential condition of economic progress in any society is an ample supply of savings, which depends on the growth of real capital. Economists agree that higher investment rates will lead to higher growth. Thus, domestic savings is considered an important determinant of growth in developing countries. However, Ghana has one of the poorest savings performances in the world. There are many reasons for the low savings rates in Ghana.
    Keywords: Domestic savings, Reforms, Time-series analysis, Finance, Ghana, Developing countries
    Date: 2023
  4. By: Maria Garcia-Vega; Apoorva Gupta; Richard Kneller
    Abstract: This paper examines how acquisition-FDI during a financial crisis, or fire-sale FDI, affects the R&D investments of target firms. We compare these effects with acquisitions that occur during periods of strong economic growth. Using a panel of Spanish firms from 2004 to 2014, we find that irrespective of when in the business cycle the acquisition occurs, the best domestic firms are cherry-picked by foreign multinationals. Using propensity score matching and difference-in-difference regressions, we find that firms acquired during crises experience smaller declines in domestic R&D than firms acquired during periods of robust growth. To explain why fire-sale FDI does not result in large declines in R&D in target firms, we rely on the macroeconomic literature on the opportunity cost of R&D over the business cycle. Consistent with this theory, we find that firms acquired during crises search for new markets and technologies by becoming more exploratory in their innovation than firms acquired during non-crisis periods.
    Keywords: foreign acquisition; recession; innovation; business cycle
    Date: 2023
  5. By: ITO Tadashi; Michael RYAN; TANAKA Ayumu
    Abstract: Using matched firm-bank-FDI data, this study explores the possibility that firms with stricter financial constraints tend to choose joint ventures with a lower ownership ratio for their foreign subsidiaries. In addition, this study tests the hypothesis that parent firms with banks as their largest shareholders have a lower stake in their foreign subsidiaries because banks are risk averse. The empirical analysis confirms that foreign subsidiary ownership ratios are negatively associated with parent firms' debt ratios. Moreover, this study finds that the greater the degree to which the parent firm has bank shareholders, the lower the parent firm's ownership share in its subsidiaries. However, this tendency weakens when a bank has an overseas subsidiary in the host country, presumably because the information asymmetry is mitigated.
    Date: 2023–03
  6. By: Florian Unger
    Abstract: This paper analyzes the impact of financial development on export concentration. I incorporate credit constraints into a trade model with heterogeneous exporters and endogenous quality choice. The model predicts that financial development increases innovation activity and export shares of larger firms. In contrast, a model variant in which exporters have to finance production costs instead of investments suggests a negative impact of financial development on export concentration as smaller firms benefit more from relaxing credit constraints. These opposing predictions are tested using export data for 70 countries over the period 1997-2014 and exploiting variation in external finance dependence across sectors. I find strong support for the predictions of the investment model that higher financial development increases export concentration among top firms, especially in sectors with high external finance dependence and large scope for quality differentiation. This effect is also present within firms: financial development induces exporters to skew their sales towards the top performing products. I finally show in a counterfactual analysis that financial frictions are quantitatively important to explain the variation in the skewness of exports across countries and sectors.
    Keywords: international trade, superstar firms, export concentration, external finance, credit constraints, financial development, innovation
    JEL: F12 F14 G32 L11
    Date: 2023
  7. By: Franziska Hunnekes; Maximilian Konradt (IHEID, Graduate Institute of International and Development Studies, Geneva); Moritz Schularick; Christoph Trebesch; Julian Wingenbach
    Abstract: In the past decade, Germany has been the world champion in exporting capital ("Exportweltmeister"). No other country invested larger amounts of savings outside its borders. However, we find that Germany plays in the third division when it comes to investment performance. To show this, we construct a comprehensive new database on the returns on foreign investment for 13 advanced economies back to the 1970s. The data reveal that Germany's annual returns on foreign assets were 2 to 5 percentage points lower than those of comparable countries. Germany ranks last among the G7 countries and earns significantly lower foreign returns within asset classes, especially for equity and foreign direct investments. These aggregate results are confirmed with micro data on equity returns by 50, 000 mutual funds worldwide. German funds perform worse across all sectors and destination countries of investment. They also seem to do a worse job in timing the market.
    Keywords: International Capital Flows; Foreign Assets; Investment Returns
    JEL: F21 F30 F31 F36 G15
    Date: 2023–03–13
  8. By: Miguel Cantillo (Universidad de Costa Rica)
    Abstract: This paper studies bank competition with borrower adverse selection. In the model, expected non-performing loan costs are high when credit is granted in booms, when risk free rates are low, or when competition is strong. I prove that full competition is suboptimal due to this last effect; that more competition improves the transmission of monetary policy, and that lending rates are always pro-cyclical. The paper examines the relative plausibility of sequential and simultaneous bank competition. I show that with asymmetric costs, bank market shares are always inversely related to their efficiency, and that bank entry does not always lower lending rates.
    Keywords: Bank competition, transmission of monetary policy, Cournot competition, adverse selection in credit markets.
    Date: 2023–03
  9. By: Jérémie Bertrand (IÉSEG School Of Management [Puteaux]); Jean-Loup Soula (EM Strasbourg - École de Management de Strasbourg); Paul-Olivier Klein (Laboratoire de Recherche Magellan - UJML - Université Jean Moulin - Lyon 3 - Université de Lyon - Institut d'Administration des Entreprises (IAE) - Lyon)
    Abstract: Trust towards banks plays a central role in theoretical literature. Diamond and Dybvig (1983) argue that in a trustworthy environment banks can easily collect deposit foster banking activity and asset transformation. Diamond and Rajan (2001) posit that a high trust environment discourages banks from creating liquidity. To address these conflicting views, the current study measures liquidity creation using Berger and Bouwman's (2009) methodology, then assesses the level of trust in the environment with four proxies and two additional instruments deployed in previous research. The results confirm a positive effect of trust in banks on liquidity creation, especially for small or state-chartered banks and during economic downturns. The results are robust to time effects and potential endogeneity concerns.
    Keywords: Banking, Liquidity Creation, Trust, Financial Intermediation
    Date: 2022–12
  10. By: mohammed, habib
    Abstract: Profitability of financial institutions play a vital role in determining the effectiveness and efficiency of the financial system globally and it is dominated by the banking industry. These banks generates profits that results panel data that requires panel model to analyze and explore determinant factors associated with its profitability. The aim of this article to model determinants of private banks profitability in Ethiopia during 2012–2021 considering its dynamic nature. Return on assets, return on equity, and net interest margin were used as profitability indicators and analyzed using dynamic panel model estimation methods based on system generalized moment estimation techniques. The exploratory data analysis result showed the profitability; return on asset was seems stable while return on equity was decreased and net interest margin was increased with decreasing rate. The model specification result showed one-step system generalized moment method estimation was an appropriate estimation technique as model estimation result directs lagged profitability, capital adequacy, asset quality and branch of banks have positive significant effect on private banks profitability. Similarly inflation rate and economic growth rate have positively determine private banks profitability on macroeconomic side. Despite to this results liquidity was significant negative bank specific determinant of private banks profitability in Ethiopia. The study result recommends consideration on capital adequacy, asset quality, liquidity, branch of banks for the private banks profitability. In addition, this study will call upcoming research to include other financial determinants suggests such as credit risk and non-performing loan with improving the estimation method of panel autoregressive distributed lag models for modeling private banks profitability in Ethiopia.
    Keywords: Dynamic Panel Model, Ethiopia, Generalized Moment Method, Panel Data, Private Banks, Profitability
    JEL: C10
    Date: 2023–03–16
  11. By: Gersbach, Hans; Rochet, Jean-Charles; von Thadden, Ernst-Ludwig
    Abstract: This paper studies the impact of corporate political influence on fiscal policy. We in-troduce different interest groups, firms and households, into a simple growth model with incomplete markets and heterogeneous agents. Firms face non-insurable id-iosyncratic productivity shocks. They finance their productive investments by issu-ing bonds but cannot issue equity. Households’ savings are invested into corporate bonds and public debt. The government selects the levels of taxes and public debt so as to maximize a weighted sum of the welfares of firms’owners and households. More government debt reduces corporate leverage, increases the risk free rate r and decreases the growth rate g. A. The weight of firms in social welfare determines whether r g at the optimum, with different dynamics in both regimes.
    Keywords: Incomplete Financial Markets; Debt, Interest; Growth; Ponzi Games; Heterogeneous Agents
    JEL: E44 E62
    Date: 2023–03–03
  12. By: Kouam, H; Kouam, S
    Abstract: Investments by the private and public sectors have formed the basis for economic growth in developing economies. The creation of goods and services for consumption hinges on the ability of market actors to lend from financial institutions. The process of credit creation is, therefore, central to economic activity, output, employment, productivity, and wage growth. Nevertheless, it is not clear that crowding out of investment occurs via lending to state entities whose ability to repay credit is contingent on oil prices and domestic economic activity. This paper finds that the impact of the public sector on per capita GDP is weaker (1.6%), while the impact of private credit is significantly larger (2.6%). Greater linkages between commercial banks and the public sector increase financial stability risks as weaker oil prices affect the ability of the public sector to repay its loans to Cameroon’s commercial banks. To bolster financial stability, commercial banks should make targeted investments in high-growth and scalable sectors that will reduce the uncertainty on their profits stemming from uncertain oil prices and late repayments by state-owned entities. Not only will a climate-centric and diversified portfolio insulate bank profits over the medium-long run, they will also reduce the exposure of their asset and liquidity positions to uncertain commodity prices.
    Keywords: Liquidity, Lending, Public Sector, Investment
    JEL: E50 E51 E52 E58 G21 G23 G24 G28
    Date: 2022–05–09
  13. By: Metiu, Norbert; Prieto, Esteban
    Abstract: The cross-sectional average of pairwise correlations across stocks traded on the NYSE, AMEX, and Nasdaq is a powerful predictor of U.S. economic activity at a horizon of one to four years. Its predictive ability is on a par with the slope of the yield curve and significantly exceeds that of some other widely used financial indicators. The macroeconomic effects of an innovation to stock return correlation in a vector autoregression are nearly identical to those of a news shock about future productivity. Thus, market-wide changes in return correlation contain information about changes in future technological developments.
    Keywords: Business Cycles, News Shock, Stock Market, Uncertainty
    JEL: E32 E44
    Date: 2023
  14. By: Cars Hommes (University of Amsterdam); Sebastian Poledna (International Institute for Applied Systems Analysis)
    Abstract: We develop an agent-based model for the euro area that fulfils widely recommended requirements for nextgeneration macroeconomic models by i) incorporating financial frictions, ii) relaxing the requirement of rational expectations, and iii) including heterogeneous agents. Using macroeconomic and sectoral data, the model includes all sectors (financial, non-financial, household, and a general government) and connects financial flows and balance sheets with stock-flow consistency. The model, moreover, incorporates many features considered essential for future policy models, such as a financial accelerator with debt-financed investment and a complete GDP identity, and allows for non-linear responses. We first show that the agent-based model outperforms dynamic stochastic general equilibrium and vector autoregression models in out-of-sample forecasting. We then demonstrate that the model can help make sense of extreme macroeconomic movements and apply the model to the three recent major economic crises of the euro area: the Financial crisis of 2007-2008 and the subsequent Great Recession, the European sovereign debt crisis, and the COVID-19 recession. We show that the model, due to non-linear responses, is capable of predicting a severe crisis arising endogenously around the most intense phase of the Great Recession in the euro area without any exogenous shocks. By analysing the COVID-19 recession, we further demonstrate the model for scenario analysis with exogenous shocks. Here we show that the model reproduces the observed deep recession followed by a swift recovery and also captures the persistent rise in inflation following the COVID-19 recession
    Keywords: agent-based models, behavioural macro, macroeconomic forecasting, microdata, financial crisis, inflation and prices, coronavirus disease (COVID- 19).
    JEL: E70 E32 E37
    Date: 2023–03–15
  15. By: Brianti, Marco (University of Alberta, Department of Economics); Cormun, Vito (Santa Clara University)
    Abstract: Using data from the Survey of Professional Forecasters, we find that a large fraction of analysts’ expectations about future economic growth is not due to technology or other shocks to fundamentals. The co-movement pattern associated with these changes is different from the one driven by fundamental shocks. Specifically, a non-fundamental improvement in expectations of future output predicts boom bust dynamics in the key macroeconomic aggregates. We offer a novel theory that explains why boom-bust dynamics emerge in response to non-fundamental expectations shocks and not to technology shocks.
    Keywords: Animal Spirit; Boom Bust; Business Cycle; Sunspot
    JEL: C32 E32
    Date: 2023–03–27
  16. By: Flora Lutz
    Abstract: I provide an integrated analysis of monetary and macroprudential policies in a model economy featuring a financial friction and a nominal wage rigidity. In this set-up, the monetary authority faces a trade-off between macroeconomic and financial stability: While expansionary counter-cyclical monetary policy prevents involuntary unemployment, it also amplifies an inefficient reallocation of capital across sectors. The main contribution of the analysis is threefold: First it highlights a novel channel through which monetary policy can impact financial stability. Second, it shows that, by itself, monetary policy can significantly mitigate the wedge between the constrained efficient and the competitive allocation. Third, regardless of the availability of macroprudential tools, stabilizing demand is usually not optimal for monetary policy.
    Keywords: Monetary Policy; Macroprudential Policy; Fire-sales; Pecuniary Externalities; Unemployment
    Date: 2023–03–10
  17. By: Erica Xuewei Jiang; Gregor Matvos; Tomasz Piskorski; Amit Seru
    Abstract: We analyze U.S. banks’ asset exposure to a recent rise in the interest rates with implications for financial stability. The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity. Marked-to-market bank assets have declined by an average of 10% across all the banks, with the bottom 5th percentile experiencing a decline of 20%. We illustrate that uninsured leverage (i.e., Uninsured Debt/Assets) is the key to understanding whether these losses would lead to some banks in the U.S. becoming insolvent-- unlike insured depositors, uninsured depositors stand to lose a part of their deposits if the bank fails, potentially giving them incentives to run. A case study of the recently failed Silicon Valley Bank (SVB) is illustrative. 10 percent of banks have larger unrecognized losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks having lower capitalization than SVB. On the other hand, SVB had a disproportional share of uninsured funding: only 1 percent of banks had higher uninsured leverage. Combined, losses and uninsured leverage provide incentives for an SVB uninsured depositor run. We compute similar incentives for the sample of all U.S. banks. Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs.
    JEL: G2 L5
    Date: 2023–03
  18. By: Barbara Meller; Oscar Soons
    Abstract: How would a central bank digital currency impact the balance sheets of the central bank and commercial banks? To tackle this question empirically, we propose a constraint optimisation model that allows individual banks to choose how to respond to deposit outflows, minimizing their costs subject to bank-specific and system-wide reserve and collateral availability and different liquidity risk preferences. We simulate the impact of a fictitious digital euro introduction in Q3-2021 using data from over 2, 000 euro area banks. The simulated impact depends on i) the amount of deposits that are withdraw and the speed at which this occurs, ii) the available liquidity in the banking system at the time of a potential digital euro introduction, iii) markets’ and supervisors’ liquidity risk preferences, iv) the bank’s business model, and v) the functioning of the interbank market. For the case of the digital euro, Bindseil (2020) and Bindseil and Panetta (2020) have suggested a €3, 000 digital euro holding limit per person. We illustrate that with such a limit, even in extremely pessimistic scenarios, the impact on banks’ liquidity risk and funding structure and on the Eurosystem balance sheet would have been contained.
    Keywords: digital currency; financial intermediation; financial stability; liquidity risk; euro area
    JEL: E52 E58 G21
    Date: 2023–03
  19. By: Mr. Maria Soledad Martinez Peria; Mr. Sergio L. Schmukler; Jasmine Xiao; Juan J. Cortina
    Abstract: China’s equity markets internationalization process started in the early 2000s but accelerated after 2012, when Chinese firms’ shares listed in Shanghai and Shenzhen gradually became available to international investors. This paper studies the effects of the post-2012 internationalization events by comparing the evolution of equity financing and investment activities for: (i) domestic listed firms relative to firms that already had access to international investors and (ii) domestic listed firms that were directly connected to international markets relative to those that were not. The paper finds large increases in financial and investment activities for domestic listed and for connected firms, with significant aggregate effects. The evidence also suggests the rise in firms’ equity issuances was primarily and initially financed by domestic investors. International investors’ portfolio holdings in Chinese equity markets and ownership in firms increased markedly only once Chinese firms’ locally issued shares became part of the MSCI Emerging Markets Index.
    Keywords: equity financing; equity market liberalization; firm investment; foreign investors; international investors; issuance activity; Stock Connect; portfolio holding; internationalization process; unconnected firm; China's equity markets; Stock markets; Stocks; Foreign corporations; Emerging and frontier financial markets; Market capitalization; Global
    Date: 2023–02–10
  20. By: Franks, Julian R.; Miao, Meng; Sussman, Oren
    Abstract: We use data on financially distressed Chinese companies in order to study a debt market where property rights are crudely defined and poorly enforced. To help with identification we use an event where a business-friendly province published new guidelines regarding the administration and enforcement of assets pledged as collateral. Although by no means a comprehensive reform of bankruptcy law or property rights, by instructing courts to enforce existing, albeit rudimentary, contractual rights the new guidelines virtually eliminated creditors runs and produced a sharp increase in the survival rate of financially-distressed companies. These changes illustrate how piecemeal reforms of property rights and their enforcement may have a significant impact on economic outcomes. Our analysis and results challenge the view that a fully fledged system of private property is a precondition for economic development.
    Keywords: Finance and development, property rights, financial distress, creditors runs
    JEL: G21 G23 G33 N25 O43
    Date: 2022
  21. By: Alfredo Schclarek; Jiajun Xu
    Keywords: Belt & Road Initiative, Panda Bonds, China Development Bank, Financial Risks, Exchange Rate Risks, Balance of Payment Crisis
    JEL: E42 F21
    Date: 2021–11
  22. By: Marcin W\k{a}torek; Jaros{\l}aw Kwapie\'n; Stanis{\l}aw Dro\.zd\.z
    Abstract: In this study the cross-correlations between the cryptocurrency market represented by the two most liquid and highest-capitalized cryptocurrencies: bitcoin and ethereum, on the one side, and the instruments representing the traditional financial markets: stock indices, Forex, commodities, on the other side, are measured in the period: January 2020--October 2022. Our purpose is to address the question whether the cryptocurrency market still preserves its autonomy with respect to the traditional financial markets or it has already aligned with them in expense of its independence. We are motivated by the fact that some previous related studies gave mixed results. By calculating the $q$-dependent detrended cross-correlation coefficient based on the high frequency 10 s data in the rolling window, the dependence on various time scales, different fluctuation magnitudes, and different market periods are examined. There is a strong indication that the dynamics of the bitcoin and ethereum price changes since the March 2020 Covid-19 panic is no longer independent. Instead, it is related to the dynamics of the traditional financial markets, which is especially evident now in 2022, when the bitcoin and ethereum coupling to the US tech stocks is observed during the market bear phase. It is also worth emphasizing that the cryptocurrencies have begun to react to the economic data such as the Consumer Price Index readings in a similar way as traditional instruments. Such a spontaneous coupling of the so far independent degrees of freedom can be interpreted as a kind of phase transition that resembles the collective phenomena typical for the complex systems. Our results indicate that the cryptocurrencies cannot be considered as a safe haven for the financial investments.
    Date: 2023–02

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