nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2023‒09‒25
fifteen papers chosen by
Georg Man,

  1. Capital Risk, Fiscal Policy, and the Distribution of Wealth By Andrea Modena; Luca Regis
  2. Did the U.S. Really Grow Out of Its World War II Debt? By Julien Acalin; Laurence M. Ball
  3. The cause and Interaction between banking crises and the business cycle By Bodunrin, Olalekan Samuel
  4. Financial Inclusion and Monetary Policy: A Study on the Relationship between Financial Inclusion and Effectiveness of Monetary Policy in Developing Countries By Gautam Kumar Biswas; Faruque Ahamed
  5. Same old song: On the macroeconomic and distributional effects of leaving a Low Interest Rate Environment By Alberto Botta; Eugenio Caverzasi; Alberto Russo
  6. The Profitability of Monetary Policy Transmission By Alex Hsu; Indrajit Mitra; Linghang Zeng
  7. Do Corporate Bond Shocks Affect Commercial Bank Lending? By Mr. Mario Catalan; Alexander W. Hoffmaister
  8. Unveiling the Interplay between Central Bank Digital Currency and Bank Deposits By Hanfeng Chen; Maria Elena Filippin
  9. Market Concentration in Fintech By Dean Corbae; Pablo D'Erasmo; Kuan Liu
  10. Does Income Inequality Affect Capital Flows? Evidence from Emerging Markets and Developing Economies By Jorge Carrera; Gabriel Montes-Rojas; Mariquena Solla; Fernando Toledo
  11. Global Capital Allocation By Florez-Orrego, Sergio; Maggiori, Matteo; Schreger, Jesse; Sun, Ziwen; Tinda, Serdil
  12. Unravelling aid funding: Linking funding allocation patterns and localization in Sierra Leone By Swetha Ramachandran
  14. Extending the Frontiers of Financial Development for Sustainability of the MENA States: The Roles of Resource Abundance and Institutional Quality By Stephen T. Onifade; Bright A. Gyamfi; Ilham Haouas; Simplice A. Asongu
  15. The Financial Market of Environmental Indices By Thisari K. Mahanama; Abootaleb Shirvani; Svetlozar Rachev; Frank J. Fabozzi

  1. By: Andrea Modena; Luca Regis
    Abstract: We develop a continuous-time model of a production economy where households face leverage constraints, uninsurable labour income shocks, and capital depreciation risk. We derive a numerical approximation of the model’s competitive equilibrium and compare it with a benchmark economy with no capital risk. Introducing capital risk generates a positive risk premium while fostering aggregate capital accumulation and safe asset demand. At the same time, it exacerbates wealth inequality by making poor households’ net worth more volatile than their wealthier peers. In this framework, we investigate the impact of fiscal policy on households’ wealth distribution and welfare. Fiscal policy influences the equilibrium wealth distribution by changing the risk premium. This channel unevenly impacts households’ consumption and asset allocation decisions, depending on their wage and net worth levels. Tax cuts on risky capital may benefit wealthy or poor households, depending on whether they are financed by raising taxes on safe assets or labour.
    Keywords: fiscal policy, incomplete market, portfolio choices, wealth distribution
    JEL: C61 E21 E62 G11
    Date: 2023–08
  2. By: Julien Acalin; Laurence M. Ball
    Abstract: The fall in the U.S. public debt/GDP ratio from 106% in 1946 to 23% in 1974 is often attributed to high rates of economic growth. This paper examines the roles of three other factors: primary budget surpluses, surprise inflation, and pegged interest rates before the Fed-Treasury Accord of 1951. Our central result is a simulation of the path that the debt/GDP ratio would have followed with primary budget balance and without the distortions in real interest rates caused by surprise inflation and the pre-Accord peg. In this counterfactual, debt/GDP declines only to 74% in 1974, not 23% as in actual history. Moreover, the ratio starts rising again in 1980 and in 2022 it is 84%. These findings imply that, over the last 76 years, only a small amount of debt reduction has been achieved through growth rates that exceed undistorted interest rates.
    JEL: E31 E43 E65 H60 H63
    Date: 2023–08
  3. By: Bodunrin, Olalekan Samuel
    Abstract: This paper analyzed the interplay between banking crises and the business cycle behaviour and its implication for the wider macroeconomy. Firstly, the business cycle of the economies was estimated using Hodrick & Prescott’s (1997) filter as a standard smoothing technique. Next, the turning points were identified, and the cycle was dated using the Harding & Pagan (2003) algorithm, an extension from Bry and Boschan (1971), with the aid of the Philippe Bracke (2011) SBBQ Stata module. Finally, after identifying the peak and trough phases, the distance between the duo was further labelled, and the entire stretch of the economies’ business cycle was classified into six phases, namely recovery, expansion, peak, recession, depression, and trough. The aim is; to ascertain the reactivity between banking crises and the individual business cycle phases and their implications for the aggregate economy. This objective is in addition to; exploring the relationship between banking crises and the cyclical behaviour of the business cycle; ascertaining the probability of banking crises induced by the cyclical behaviour of the business cycle; and establishing the gaps generated by the interactions between banking crises and; the output, the industrial production and the credit gaps. The panel vector autoregressive (pVAR) model was employed. Also, the logistic regression model and the Harding & Pagan (2003) concordance index were applied with diagnostic tests and the adaptive LASSO for robustness checks. The result found three broader categories of banking crises. These are banking crises made possible by; liquidity pressure during economic expansions, excessive leverage(boom and bust) and economic downturns. Banking crises severely contracted the business cycle, via the trough, depression, and recovery phases, with feedback mechanisms lasting about four years. The business cycle caused banking crises in its extreme region- the topmost peak phase, the lowest trough phase, and the recovery phase. The result further confirmed that banking crises naturally occur during the Depression, Recovery, and Trough phases and weakly on the Expansion phases (in that order). Nations slipped from peak to trough during banking crises, but none moved from trough to peak. These results emphasised the importance of macro-financial linkages and their vulnerabilities, suggesting need for policy synergy and considering the business cycle phases in designing and implementing economic policies.
    Keywords: Banking crises, Business Cycle
    JEL: E32 G21 N1 N14
    Date: 2023–01–14
  4. By: Gautam Kumar Biswas; Faruque Ahamed
    Abstract: The study analyzed the impact of financial inclusion on the effectiveness of monetary policy in developing countries. By using a panel data set of 10 developing countries during 2004-2020, the study revealed that the financial inclusion measured by the number of ATM per 100, 000 adults had a significant negative effect on monetary policy, whereas the other measure of financial inclusion i.e. the number of bank accounts per 100, 000 adults had a positive impact on monetary policy, which is not statistically significant. The study also revealed that foreign direct investment (FDI), lending rate and exchange rate had a positive impact on inflation, but only the effect of lending rate is statistically significant. Therefore, the governments of these countries should make necessary drives to increase the level of financial inclusion as it stabilizes the price level by reducing the inflation in the economy.
    Date: 2023–08
  5. By: Alberto Botta (School of Accounting, Finance and Economics, University of Greenwich, London, UK); Eugenio Caverzasi (Department of Economics, Università degli Studi dell’Insubria, Varese, Italy); Alberto Russo (Department of Economics and Social Sciences, Università Politecnica delle Marche, Ancona, Italy and Department of Economics, Universitat Jaume I, Castellón, Spain)
    Abstract: This paper analyzes the macroeconomic and distributional implications of central banks’decisions to raise interest rates after a prolonged period at near the Zero Lower Bound (ZLB). The main goal of our study is to assess the interaction between monetary policy, inequality, and financial fragility, in a financialized economic system. Financialization is here portrayed as the presence in the economy of complex financial products, i.e., assetbacked securities, produced via the securitization of banks’ loans. We do so in the context of a hybrid Agent-Based Model (ABM). We first compare the prevailing macroeconomic and financial features of a low interest rate environment (LIRE) with respect to a “Great Moderation”(GM)-like setting. As expected, we show that LIRE tends to stimulate faster growth and higher employment, and to reduce income and wealth inequality, as well as (poor) households’ indebtedness. Consistent with existing empirical literature, this comes at the cost of higher inflation and some signs of financial system’s fragility, i.e., lower banks’ profitability and Capital Adequacy Ratio (CAR), and higher “search for risk” given by credit extension to poorer households. We then show that increases in the central bank’s policy rate, as motivated by the central bank’s willingness to reduce inflation, effectively curb price dynamics and accomplish with central bank’s inflation targeting mandate. Higher interest rates also improve commercial banks’ CAR and profitability. However, they also cause a pronounced increase in non-performing loans (stronger tan what possibly observed in a GM scenario) and some worrisome macro-financial dynamics. In fact, higher interest rates give rise to higher households’ and overall economy indebtedness as allowed by wealthier households’ demand for high-yield complex financial products and mounting securitization. We finally show how financialization structurally changes the functioning of the economy and the behavior of central banks. Financialization actually contributes to create a (private sector) debt-led economy, which becomes structurally more resistant to central bank’s attempts to control inflation. Central bank’s reaction in terms of higher interest rates could likely come with perverse distributional consequences.
    Keywords: Low interest rate environment, Contractionary monetary policy, Securitization
    JEL: E24 E44 E52
    Date: 2023
  6. By: Alex Hsu; Indrajit Mitra; Linghang Zeng
    Abstract: We provide firm-level evidence that Federal Open Market Committee announcements have real effects by changing expectations of firm profitability. We use an existing decomposition of a monetary policy shock into a central bank information component (CBI) and a conventional monetary component (MP). We find (1) firms with a higher value of capital asset pricing model (CAPM) beta have a higher investment rate sensitivity to the CBI component; no similar heterogeneity in investment response is observed for the MP component. We also find (2) the heterogeneity in investment sensitivity is due to innovations to firm profitability.
    Keywords: monetary policy; Fed information shocks; investments; CAPM beta
    JEL: E22 E52 G31
    Date: 2023–06–20
  7. By: Mr. Mario Catalan; Alexander W. Hoffmaister
    Abstract: Understanding how corporate bond market disruptions are transmitted to the rest of the financial system is essential to gauge systemic financial risk and design policy responses. In this study, we extend the vector autoregression model of Gilchrist and Zakrajšek (2012) to explicitly account for the role of commercial banks in the transmission of corporate bond credit spread shocks. We find that corporate bond market shocks can reduce commercial bank lending activity by tightening loan supply. Policies designed to contain stress in the corporate bond market can thus mitigate systemic risk by limiting contagion to the commercial banking sector.
    Keywords: excess bond premium; banks; VAR models; financial markets and the macroeconomy; systemic risk; contagion.
    Date: 2023–08–04
  8. By: Hanfeng Chen; Maria Elena Filippin
    Abstract: We extend the Real Business Cycle model in Niepelt (2022) to analyze the risk to financial stability following the introduction of a central bank digital currency (CBDC). CBDC competes with commercial bank deposits as households' source of liquidity. We consider different degrees of substitutability between payment instruments and review the equivalence result in Niepelt (2022) by introducing a collateral constraint banks must respect when borrowing from the central bank. When CBDC and deposits are perfect substitutes, the central bank can offer loans to banks that render the introduction of CBDC neutral to the real economy. We show that the optimal level of the central bank's lending rate depends on the restrictiveness of the collateral constraint: the tighter it is, the lower the loan rate the central bank needs to post. However, when CBDC and deposits are imperfect substitutes, the central bank cannot make banks indifferent to the competition from CBDC. It follows that the introduction of CBDC has real effects on the economy.
    Date: 2023–08
  9. By: Dean Corbae; Pablo D'Erasmo; Kuan Liu
    Abstract: This paper discusses concentration in consumer credit markets with a focus on fintech lenders and residential mortgages. We present evidence that shows that concentration among fintech lenders is significantly higher than that for bank lenders and other nonbank lenders. The data also show that the overall concentration in mortgage lending has declined between 2011 and 2019, driven mostly by a reduction in concentration among bank lenders. We present a simple model to show that changes in lender financial technology (interpreted as improvements in quality of loan services) explain more than 50 percent of the increase in fintech market shares and 43 percent of the increase in fintech concentration. This change in concentration in the fintech industry may have important implications for regulatory policy and financial stability.
    Keywords: fintech; concentration; mortgage lending
    JEL: G2 L1 L5
    Date: 2023–06–08
  10. By: Jorge Carrera (CONICET/UNLP/BCRA); Gabriel Montes-Rojas (IIEP-BAIRES-UBA/CONICET); Mariquena Solla (UNLP/BCRA); Fernando Toledo (UNLP/BCRA)
    Abstract: We assess the effect of income inequality on capital flows. We differentiate between aggregate capital inflows (external liabilities accumulation) and outflows (external assets accumulation) and disaggregated public andprivate capital inflows and outflows. We estimate dynamic panel data models using annual observations for Emerging Markets and Developing Economies during the 1999-2019 period. We find that the Top 1 and theTop 10 inequality measures are positive and statistically significant for aggregate and private inflows, and the Gini disposable income is statistically significant only for one explored method. The evidence alsoshows that there is a weak effect on private outflows, robust across methods only at the aggregate specification. The results also suggest that financial openness is positively associated with a greater effect ofinequality.
    Keywords: Income Inequality, Capital Flows, Financial Openness, Panel Data Models
    JEL: D31 F21 F32 F41 C23
    Date: 2023–08
  11. By: Florez-Orrego, Sergio; Maggiori, Matteo; Schreger, Jesse; Sun, Ziwen; Tinda, Serdil
    Abstract: We survey the literature on global capital allocation. We begin by reviewing the rise of cross-border investment, the shift towards portfolio investment, and the literature focusing on aggregate patterns in multilateral and bilateral positions. We then turn to the recent literature that uses micro-data to document patterns in global capital allocations. We focus on the importance of the currency of denomination of assets in international portfolios and the role that tax havens and offshore financial centers play in intermediating global capital. We conclude with directions for future research in this area.
    Date: 2023–08–18
  12. By: Swetha Ramachandran
    Abstract: Development assistance funding by international donors is rarely channelled to/through local actors. While there are strong normative and practical arguments for localizing funding, progress has been piecemeal as donors are largely left to their own devices to decide how, when, where, and how much to localize. This paper explores the antecedents to donor aid allocation and poses the question: 'How and why do donors vary in their extent of localization (as defined by the use of local channels to disburse aid funding)?'.
    Keywords: Development aid, Foreign aid, Mixed methods, Sierra Leone, Funding
    Date: 2023
  13. By: BIANCARDI Daniele (European Commission - JRC); MARTINEZ CILLERO Maria (European Commission - JRC)
    Abstract: This note presents the latest trends in the investment behaviour of multinational enterprises focusing on non-EU (foreign) investors. It looks at merger and acquisition (M&A) deals and other equity investments of at least 10% of capital of the target company in the EU, as well as at greenfield projects.
    Date: 2023–08
  14. By: Stephen T. Onifade (KTO Karatay University, Konya, Turkey); Bright A. Gyamfi (Ä°stanbul Ticaret University, Turkey); Ilham Haouas (Abu Dhabi, UAE); Simplice A. Asongu (Johannesburg, South Africa)
    Abstract: Resource abundance characterizes economies within the MENA region from North Africa to the Middle East. As such, to improve financial development (FD) for regional economic sustainability, this study provides a comprehensive analysis of the roles of natural resources abundance and institutional quality indicators on the region’s FD while underscoring the inflationary levels and general economic growth trends amidst rising globalization. The adopted empirical strategy (CS-ARDL and AMG) is employed for potential cross-sectional dependency (CD) and slope homogeneity in the regional data spanning over two decades (2000-2020). Unlike the extant literature, two separate regional FD indicators were considered for an insightful analysis namely, banking financial services via domestic credit to private sector, and financial stability via the Z-score values showing the tendencies of default in a country's banking structure. Regardless of the FD indicator, the results reveal that natural resources, growth trends, and inflationary levels significantly spur long-run regional FD thereby invalidating the financial resource curse hypothesis in the region. Furthermore, both institutional quality levels and globalization produced detrimental impacts on FD levels. However, the interaction between institutional quality levels and natural resources shows a desirable FD-stimulating effect in the region, noticeably when FD is proxied by the Z-score. Thus, implying that stronger institutions are crucial for MENA’s overall financial stability vis-Ã -vis reduction in the risk of default in the banking system. Hence, policy recommendations including the strengthening of institutional capacities among others, were suggested to regional authorities towards harnessing resources for sustainable regional FD.
    Keywords: Natural resources, Financial development, Institutions, MENA region, Sustainable growth
    JEL: Q33 P48 E44 O53 O55
    Date: 2023–01
  15. By: Thisari K. Mahanama; Abootaleb Shirvani; Svetlozar Rachev; Frank J. Fabozzi
    Abstract: This paper introduces the concept of a global financial market for environmental indices, addressing sustainability concerns and aiming to attract institutional investors. Risk mitigation measures are implemented to manage inherent risks associated with investments in this new financial market. We monetize the environmental indices using quantitative measures and construct country-specific environmental indices, enabling them to be viewed as dollar-denominated assets. Our primary goal is to encourage the active engagement of institutional investors in portfolio analysis and trading within this emerging financial market. To evaluate and manage investment risks, our approach incorporates financial econometric theory and dynamic asset pricing tools. We provide an econometric analysis that reveals the relationships between environmental and economic indicators in this market. Additionally, we derive financial put options as insurance instruments that can be employed to manage investment risks. Our factor analysis identifies key drivers in the global financial market for environmental indices. To further evaluate the market's performance, we employ pricing options, efficient frontier analysis, and regression analysis. These tools help us assess the efficiency and effectiveness of the market. Overall, our research contributes to the understanding and development of the global financial market for environmental indices.
    Date: 2023–08

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