nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2023‒10‒02
twenty papers chosen by
Georg Man,

  1. Why Does the Yield Curve Predict GDP Growth? The Role of Banks By Camelia Minoiu; Andrés Schneider; Min Wei
  2. Occupational Choice, Human Capital, and Financial Constraints By Rui Castro; Pavel Sevcik
  3. Entrepreneurship and the Efficiency Effects of Migration By Gustavo González
  4. Internal Migration, Remittances and Economic Development By Xiameng Pan; Chang Sun
  5. The Great Indian Savings Puzzle By Chetan Ghate; Pawan Gopalakrishnan; Anuradha Saha
  6. Patterns and Drivers of Financial Sector Growth in the Digital Age: Insights from a Study of Industrialized Economies By Khuong Vu; Simplice Asongu
  7. Forecasting Risks to the Canadian Economic Outlook at a Daily Frequency By Chinara Azizova; Bruno Feunou; James Kyeong
  8. Decoding Financial Crises: Analyzing Predictors and Evolution By JEONG, Young Sik; BAEK, Yaein
  9. Insurers’ investment behaviour and the coronavirus (COVID-19) pandemic By Ghiselli, Angelica; Fay, Constanze
  10. "Large Fires and the Rise of Fire Insurance in Pre-war Japan" By Tetsuji Okazaki; Toshihiro Okubo; Eric Strobl
  11. Bank Development and Unemployment in Kenya: An Empirical Investigation By S. Nyasha; M.T. Musakwa; N.M. Odhiambo
  12. Does Tourism Influence Financial Development in Kenya? By MT Musakwa; N.M. Odhiambo
  13. Building State Capacity: What Is the Impact of Development Projects? By Vincenzo Di Maro; David K. Evans; Stuti Khemani; Thiago Scot
  14. Aid's impact on social protection in low- and middle-income countries By Miguel Niño-Zarazúa; Alma Santillán Hernández
  15. Strategies to Raise Public Awareness on Development Cooperation By Yun, Jeonghwan
  16. Global Drivers and Macroeconomic Volatility in EMEs: a Dynamic Factor, General Equilibrium Perspective By Gent Bajraj; Andrés Fernández; Miguel Fuentes; Benjamín García; Jorge Lorca; Manuel Paillacar; Juan Marcos Wlasiuk
  17. Hard Commodities Hit Harder: Global Financial Risk and Commodity Exporters By Gabriela Contreras
  18. Stocks, Bonds and the US Dollar - Measuring Domestic and International Market Developments in an Emerging Market By Nicolas Eterovic; Dalibor Eterovic
  19. Foreign Exchange Intervention with UIP and CIP Deviations: The Case of Small Safe Haven Economies By Philippe Bacchetta; Kenza Benhima; Brendan Berthold
  20. International Welfare Gains from Sharing Climate-Risk By Felix Kubler

  1. By: Camelia Minoiu; Andrés Schneider; Min Wei
    Abstract: We provide evidence on the effect of the slope of the yield curve on economic activity through bank lending. Using detailed data on banks’ lending activities coupled with term premium shocks identified using high-frequency event study or instrumental variables, we show that a steeper yield curve associated with higher term premiums (rather than higher expected short rates) boosts bank profits and the supply of bank loans. Intuitively, a higher term premium represents greater expected profits on maturity transformation, which is at the core of banks’ business model, and therefore incentivizes bank lending. This effect is stronger for ex-ante more leveraged banks. We rationalize our findings in a portfolio model for banks.
    Keywords: predictive power of the yield curve; term spread; term premium; bank lending; bank profitability; event study; instrumental variable
    Date: 2023–07–10
  2. By: Rui Castro (McGill University); Pavel Sevcik (University of Quebec in Montreal)
    Abstract: We study the aggregate productivity effects of firm-level financial frictions. Credit constraints affect not only production decisions, but also household level schooling decisions. In turn, entrepreneurial schooling decisions impact firm-level productivities, whose cross-sectional distribution becomes endogenous. In anticipation of future constraints, entrepreneurs under-invest in schooling early in life. Frictions lower aggregate productivity because talent is misallocated across occupations, and capital misallocated across firms. Firm level productivities are also lower due to schooling distortions. These effects combined account for between 36 and 68 percent of the U.S.-India aggregate productivity difference. Schooling distortions are the major source of aggregate productivity differences.
    Keywords: Aggregate Productivity, Financial Frictions, Entrepreneurship, Human Capital, Misallocation
    JEL: E24 I25 J24 O11 O15 O16 O47
    Date: 2023–08
  3. By: Gustavo González
    Abstract: This paper constructs and calibrates a parsimonious two-country dynamic general equilibrium model of entrepreneurship and migration. Countries differ in their TFP and degree of financial frictions. The model is calibrated to replicate the economic and migratory situation of the United States and the rest of the world. I evaluate the impact of changing migration barriers on GDP per capita, average firms productivity, business ownership rates, and consumption on both regions. I find that migration barriers have a non-monotone impact on the average productivity of the host coun-try, depending this on the entrepreneurial skill and mass of people that move in and are displaced by entrants. A migration policy that favors the entry of foreign people with a higher entrepreneurial drive would reduce profits of native entrepreneurs, but would make the economy more efficient and would lift the welfare of workers of the host economy.
    Date: 2023–07
  4. By: Xiameng Pan; Chang Sun
    Abstract: We develop a quantitative spatial equilibrium model with endogenous migration and remittance decisions within households to examine the joint effect of migration and remittances on economic development. We apply the model to internal migration in China. Counterfactual analysis of the calibrated model shows that the presence of remittances increases migration and welfare, reduces regional inequality and facilitates structural change. Compared to a conventional single-person migration model, our household model suggests a larger reduction in regional inequality and stronger reallocation of employment from agriculture to manufacturing and services in response to the decline in migration costs over the period of 2000 to 2010.
    Keywords: remittances, migration, structural change, spatial equilibrium
    JEL: O10 R10 R20
    Date: 2023
  5. By: Chetan Ghate; Pawan Gopalakrishnan; Anuradha Saha (Institute of Economic Growth, Delhi)
    Abstract: India’s savings rate surged from 13% in 1970 to 38% in 2008, declining steadily thereafter to 30% in 2019. Unlike other developing or developed nations, the savings rate in India, and some other countries, shows a hump-shaped trajectory with its peak coinciding with the Great Recession of 2007-2009. We build a neoclassical monetary-growth model with perfect foresight to explain the long-run savings pattern in India. We find that the post-2009 decline in inflation is a key factor in explaining the decline in the savings rate. Since the fall in inflation increases future wealth, perfect foresight induces households to increase consumption and lower savings in the future. Consumption smoothing and risk aversion induce households to increase consumption in the initial periods as well. While this smoothes consumption along the transition path, it reduces savings in the initial periods. Thus, household savings are low but rising in the 1990s, peaking along with inflation in 2008 and then declining post-2008. The fit of the model improves considerably when we extend the model to allow for two types of agents: Ricardian and Rule of Thumb. Our model predicts a dynamic association between inflation and household savings that mimics the hump-shaped pattern in savings that India and some other countries have experienced.
    Date: 2023
  6. By: Khuong Vu (National University of Singapore, Singapore); Simplice Asongu (Johannesburg, South Africa)
    Abstract: The financial sector in advanced economies has undergone significant evolution driven by restructuring, globalization, and the digital revolution, which have profoundly shaped its developmental dynamics. This study investigates the forces behind the growth and convergence of the financial sector across 13 advanced economies from 2000 to 2015, focusing on the effects of digital transformation. The investigation unveils several noteworthy findings concerning the financial sector. First, most nations experienced substantial growth in value-added, coupled with a significant decrease in employment and robust advancements in labor productivity. Next, the primary drivers of labor productivity growth and convergence across many economies were driven by total factor productivity, labor quality, and digital transformation. Lastly, digital transformation not only directly contributed to the augmentation of labor productivity, as quantified through growth accounting estimation, but also wielded a considerable impact on the expansion of total factor productivity and the streamlining of the workforce.
    Keywords: financial sector; productivity; digital transformation; innovation; catchup; industrialized economies
    JEL: O16 O30 O40 O57
    Date: 2023–01
  7. By: Chinara Azizova; Bruno Feunou; James Kyeong
    Abstract: In this paper, we estimate the distribution of future inflation and growth in real gross domestic product (GDP) for the Canadian economy at a daily frequency. To do this, we model the conditional moments (mean, variance, skewness and kurtosis) of inflation and GDP growth as moving averages of economic and financial conditions. Then, we translate the conditional moments into conditional distributions using a flexible parametric distribution known as the skewed generalized error distribution. We show that the probabilities of inflation and GDP growth derived from the conditional distributions accurately reflect realized outcomes during the sample period from 2002 to 2022. Our methodology offers daily-frequency forecasts with flexible forecasting horizons. This is highly useful in an environment of elevated uncertainty surrounding the inflation and growth outlook.
    Keywords: Econometric and statistical methods; Business fluctuations and cycles
    JEL: C32 C58 E44 G17
    Date: 2023–09
    Abstract: We examine factors that predict financial crises and the evolution of financial crises using non-traditional methodologies, such as machine learning and system dynamics. Firstly, in our random forest model, the top six most important predictors among 12 indicators for the entire period (1870-2017) are the slope of the yield curve, the CPI, consumption, the debt service ratio, equity return, and public debt. Secondly, even though the manifestations of financial crises differ in each case, five common characteristics have been identified by examining various past financial crisis cases using a system dynamics approach (causal loop diagram). The first characteristic is a feedback loop that reinforces credit expansion. Next, the feedback loop leads to the buildup of financial crisis risk. Third, there is the shock that triggers the financial crisis. Fourth, there are risk-spreading factors. Lastly, individual financial crises do not end in themselves but have the common characteristic of becoming the seeds of new crises. In conclusion, two key findings emerge. First, the financial crisis is a systemic problem rather than an individual risk factor. Second, in diagnosing the recent situation, the results point to the risk of the financial crisis spreading.
    Keywords: Financial Crisis; Economic Crisis; Machine Learning; System Dynamics
    Date: 2023–08–04
  9. By: Ghiselli, Angelica; Fay, Constanze
    Abstract: This research explores two aspects of European insurers’ investment behaviour related to crises. While they are often considered as financial market stabilisers and long-term investors, there is currently a lack of knowledge about insurers’ investment behaviour in crises under the regulatory Solvency II regime implemented in 2016. With assets of nearly €9 trillion and bond holdings of more than €3 trillion in Q2 2022, European insurers are important financial intermediaries and finance European economies. With an empirical study, we investigate their reaction to the asset price shock at the onset of the coronavirus (COVID-19) pandemic in the first quarter of 2020 and explore cyclical investment behaviour by replicating Timmer’s (2018) study with fixed effects panel regressions. We use a large cross-country dataset, with the novelty of exploiting cross-country heterogeneity for European countries with 458, 758 security-level observations from 2017 to 2022. Overall, our findings are very relevant from a policy perspective as they suggest active and heterogeneous cyclical investment behaviour in the European insurance market with differences across issuer and holder countries of domicile.
    Keywords: Cyclicality, Debt Capital Flows, Financial Stability, Insurance companies, Pandemic, Portfolio Allocation
    Date: 2023–09
  10. By: Tetsuji Okazaki (Faculty of Economics, The University of Tokyo); Toshihiro Okubo (Faculty of Economics, Keio University); Eric Strobl (Department of Economics, University of Bern)
    Abstract: We explore the role that large fires played in the early developed of the fire insurance industry of pre-WWII Japan. To this end we construct a prefecture level data set spanning thirty years. Our econometric results show that large fires led to an increase in new policies and policy renewals, a result that is in line with historical narratives that insurance companies used these events to advertise their business. We also show that this subsequent surge in renewals and new policy holders led to more fraudulent behaviour by increasing the number of small fires due to arson, whereas there was no effect on unintentionally set small fires. While we are unable to identify whether this was due to adverse selection of new policy holders or moral hazard behaviour of existing ones, anecdotal evidence that is more likely to have been the latter.
    Date: 2023–09
  11. By: S. Nyasha (University of South Africa); M.T. Musakwa (University of South Africa); N.M. Odhiambo (University of South Africa)
    Abstract: This study has empirically investigated the impact of bank development on unemployment in Kenya, based on time-series data spanning from 1991 to 2019. Using the ARDL bounds testing approach, the results of the study have revealed that in Kenya, the impact of bank development on unemployment, though time-invariant, depends largely on the proxy used to measure the level of bank development. Consistent with expectations, bank development – as proxied by liquid liabilities, bank deposits, deposit money bank assets and the banking development index – has been found to have a negative impact on unemployment in Kenya. However, when bank development is proxied by the domestic credit to private sector by banks, its impact on unemployment was found to be statistically insignificant. These results were found to apply consistently in the long run and in the short run.
    Date: 2022–06
  12. By: MT Musakwa (University of South Africa); N.M. Odhiambo (University of South Africa)
    Abstract: In this study, we investigate the impact of tourism on financial development in Kenya using time series data from 1995 to 2017. The study uses the autoregressive distributed lag (ARDL) bound testing approach to cointegration and error correction model to examine this linkage. To increase the robustness of the results, the study uses two proxies of financial development, namely broad money (bank-based financial development proxy) and total value of stocks traded (market-based financial development proxy). Results show that tourism has an insignificant impact on financial development in Kenya – both in the short and in the long run. The results apply irrespective of whether the financial development is proxied by a bank-based financial development indicator or by a market-based financial development indicator. This finding points to the fact that, although tourism is one of the main sources of foreign exchange in Kenya, it has no direct impact on financial development. The findings from this study add value to policy makers in Kenya by revealing the insignificant impact tourism has on financial development, although it is contrary to other studies that found a positive contribution. Based on the findings, Kenya may not anchor its financial development policies on tourism.
    Date: 2022–06
  13. By: Vincenzo Di Maro (World Bank); David K. Evans (Center for Global Development); Stuti Khemani (World Bank); Thiago Scot (UC Berkeley; World Bank)
    Abstract: Although research has established the importance of state capacity in economic development, less is known about how to build that capacity and the role of external partners in the process. This paper estimates the impact of a typical development project designed to build state capacity in a low-income country. Specifically, it evaluates a multilateral development bank project in Tanzania, which incentivized investments in local state capacity by offering grants conditional on institutional performance scores. The paper uses a difference-in-differences methodology to estimate the project impact, comparing outcomes between 18 project and 22 non-project local governments over 2016–18. Outcomes were measured through two rounds of primary surveys of nearly 500 local government officials and nearly 3, 000 households. Over the course of the project, measured state capacity improved in project areas, but due to comparable gains in non-project areas, the project’s value-added to change in state capacity is estimated to be zero across all the dozens of relevant variables in the surveys. The data suggest that state capacity is evolving in Tanzania through endogenous changes in trust and legitimacy in the country rather than from financial incentives offered by external partners.
    Keywords: state capacity, governance, decentralizations, performance-based financing
    JEL: D02 O10 O19
    Date: 2021–12–08
  14. By: Miguel Niño-Zarazúa; Alma Santillán Hernández
    Abstract: This study conducts an international comparative analysis of the recent evolution of social protection systems in sub-Saharan Africa (SSA), Latin America and the Caribbean (LAC), and Asia-Pacific (APAC) regions, paying particular attention to the role of foreign aid in these dynamics. It asks: Has foreign aid contributed to the development of social protection systems? If so, what actors have driven this process? What modalities and financial instruments have been used to support social protection systems?
    Keywords: Foreign aid, Social protection, Global south, Instrumental variable
    Date: 2023
    Abstract: "From aid recipient to donor” is a slogan commonly used to promote Korea’s development cooperation. The slogan not only represents HOW Korea tries to contribute to the developing world with its unique development experience, but it also shows WHY Korea thinks they should. This report quantitiatively evaluates the efficacy of public awareness strategy in Korea. Utilizing a survey experiment data from “Survey for Public Awareness in Korea on Development Cooperation (2022), ” I show how better understanding on the international actors of development cooperation makes a difference in the public awareness. Specifically, those with higher level of "trust" on international organization and developing countries are likely to exert complementary effect and show higher support on Korea's contribution, once provided of descriptive news about current challenges in developing world. While negative imagery seems induce more immediate response on ODA support, such complementary effect implies the importance of building a social trust about the global community and promoting better understanding of the developing world, and how the public awareness can lead to a substantial support of Korea's ODA in the long-run, without facing "compassion fatigue."
    Keywords: Development Cooperation; Public Awareness; GCED
    Date: 2023–07–19
  16. By: Gent Bajraj; Andrés Fernández; Miguel Fuentes; Benjamín García; Jorge Lorca; Manuel Paillacar; Juan Marcos Wlasiuk
    Abstract: We study the role of global drivers in emerging market economies (EMEs)’ business cycles. Using a dynamic factor model, we first pin down the global drivers that are relevant to a sample of twelve EMEs. Our identification assumption allows for the well-known global financial cycle to coexist with additional global factors of different nature, i.e. commodities, growth/productivity. Next, to better understand how these global forces are transmitted into EMEs we zoom in on Chile—one of the EMEs in the sample—and augment a large-scale DSGE regularly used for policy analysis with the estimated global dynamic factor structure. This allows us to document the general equilibrium channels through which shocks in these global factors are transmitted into the business cycle of Chile and, in turn, the policy challenges that they entail. Our findings indicate a preponderant role of global drivers for EMEs’ business cycles, with a third of their macro variability being traced back to shocks in global dynamic factors. While the global financial cycle is a relevant force, a factor associated to global prices and commodities appears equally important, with a relatively modest role played by pure growth/productivity forces. The general equilibrium analysis for Chile reveals that while some of the ensuing effects of shocks to the financial cycle offset each other, the opposite occurs when a shock to global prices materializes, calling for a more active monetary policy response.
    Date: 2022–09
  17. By: Gabriela Contreras
    Abstract: In this study, I investigate the response of commodity exporters to the global financial cycle and how it depends on the type of commodity exported. I first show that following an upsurge in global financial risk, the prices of hard commodities (such as energy, metals, and minerals) decline considerably more than soft commodities. Through a panel SVAR analysis, I compare the reactions of hard and soft commodity exporters to an unexpected increase in global financial risk. My findings reveal that hard commodity exporters experience a more significant decline in their commodity terms of trade, a higher increase in their country spread, and a more substantial reduction in output. I set up a small open economy model to explore the effects of global risk shocks on country spreads, depending on the type of commodities an economy exports. The results of this model suggest that global risk shocks are primarily transmitted through commodity prices, which means that hard commodity exporters are impacted more severely due to the composition of their exports.
    Date: 2023–08
  18. By: Nicolas Eterovic; Dalibor Eterovic
    Abstract: We propose a novel specification strategy using a SVAR identified with zero and sign-restrictions to uncover real-time financial shocks in an emerging market. By adding a foreign exogenous block and differentiating between local and US risk premia, we build on the literature that employs economically intuitive sign restrictions on the comovement of stocks and bonds to distinguish between different types of news shocks. We then apply our methodology to Chile’s financial markets. Our main results are the following. First, for Chilean financial assets, US shocks account for approximately 12% of the volatility of both short and long rates and 25% of the volatility of the stock market. Second, the transmission of US shocks to local assets comes mainly through risk aversion shocks and pure risk premia, followed by US monetary policy shocks. Third, the introduction of an exogenous block allows to better capture the effects of central bank communication around monetary policy meetings from both the Central Bank of Chile and the Federal Reserve.
    Date: 2022–10
  19. By: Philippe Bacchetta (University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)); Kenza Benhima (University of Lausanne; Centre for Economic Policy Research (CEPR)); Brendan Berthold (University of Lausanne)
    Abstract: We examine the welfare-based opportunity cost of foreign exchange (FX) intervention when both CIP and UIP deviations are present. We consider a small open economy that receives international capital flows through constrained international financial intermediaries. Deviations from CIP come from limited arbitrage or through a convenience yield, while UIP deviations are also affected by risk. We show that the sign of CIP and UIP deviations may differ for safe haven countries. We find that there may be a benefit, rather than a cost, of FX reserves if international intermediaries value the safe haven properties of a currency more than domestic households. We show that this has been the case for the Swiss franc and the Japanese Yen. We examine the optimal policy of a constrained central bank planner in this context.
    Date: 2023–08
  20. By: Felix Kubler (University of Zurich; Swiss Finance Institute)
    Abstract: In this paper, we consider a heterogeneous agents model of a production economy with uncertain climate change and evaluate the welfare gains from the introduction of securities that pay contingent on average surface temperature and total yearly emissions. Since different regions will be affected dramatically differently by climate change, potential welfare gains from sharing climate risk are large. In our benchmark calibration, the region most affected by climate change gains almost 10 percent in wealth equivalent welfare. This takes into account price effects and assumes no transfers. With transfers, the completion can be Pareto-improving, with the poorest region gaining more than 15 percent. We conduct a global sensitivity analysis where we consider a range of parameter values that are considerably more conservative than in the benchmark. We find that the result of significant welfare gains is robust, although they are, on average, much smaller than in our benchmark. By computing first-order Sobol’ indices, we demonstrate that the main driver of uncertainty is the standard deviation of the equilibrium climate sensitivity.
    Keywords: climate change, financial innovations, heterogeneous agents, risk-sharing, environmental policy
    JEL: C61 D52 D62 Q51 Q54
    Date: 2023–09

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