nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2023‒11‒13
seventeen papers chosen by
Georg Man,

  1. Impact of financial inclusion on economic growth: review of existing literature and directions for future research By Ozili, Peterson
  2. Leverage Cycle Theory of Economic Crises and Booms By John Geanakoplos
  3. THE EXPANSIONARY EFFECTS OF HOUSING CREDIT SUPPLY SHOCKS By Mirela Sorina Miescu; Giorgio Motta; Dario Pontiggia; Raffaele Rossi
  4. A time-varying finance-led model for U.S. business cycles By Marcio Santetti
  5. Inflation and growth in developing economies: A tribute to Professor Thirlwall By Nell, Kevin
  6. Flexible Inflation Targeting and Macroeconomic Performance: Evidence from ASEAN By Nuwat Nookhwun; Rawipha Waiyawatjakorn
  7. On the Negatives of Negative Interest Rates By Aleksander Berentsen; Romina Ruprecht; Hugo van Buggenum
  8. Firm Balance Sheet Liquidity, Monetary Policy Shocks, and Investment Dynamics By Priit Jeenas
  9. Quantitative Easing in the Euro Area: Implications for Income and Wealth Inequality By Dusan Stojanovic
  10. Financial Stress and Economic Activity: Evidence from a New Worldwide Index By Hites Ahir; Mr. Giovanni Dell'Ariccia; Davide Furceri; Mr. Chris Papageorgiou; Hanbo Qi
  11. A systematic review of early warning systems in finance By Ali Namaki; Reza Eyvazloo; Shahin Ramtinnia
  12. Asset Bubbles and Credit Constraints: Comment By Takeo Hori; Ryonghun Im
  13. Integration or fragmentation? A closer look at euro area financial markets By Martin Feldkircher; Karin Klieber
  14. Die vergessene vierte Säule: Die Gründung von Staats und Landesbanken in der deutschen Kreditwirtschaft By Wixforth, Harald
  15. Review - Ghassan Moazzin: Foreign banks and global finance in modern China. Banking on the Chinese frontier, 1870 1919 By Liu, Yi
  16. Firms’ Capital Structure and Employment in the Aftermath of the 2008-9 Financial Crisis By Antonio Acconcis; Daniela Fabbri; Annamaria Menichini
  17. Political risk and external finance: Evidence from cross-country firm-level data By Olayinka Oyekola; Meryem Duygun; Samuel Odewunmi; Temitope Fagbemi

  1. By: Ozili, Peterson
    Abstract: The impact of financial inclusion on economic growth is a topic that is generating widespread interest among researchers and practitioners. We review the existing literature to highlight the state of research in the literature and identify new opportunities for innovative research. We used a thematic literature review methodology which involves dividing the review along relevant themes. We find that significant research on the topic emerged in the post-2016 years. Most of the existing studies are from developing countries and from the Asian and African regions. Existing studies have not utilized relevant theories in explaining the impact of financial inclusion on economic growth. Most studies report a positive impact of financial inclusion on economic growth while very few studies show a negative impact. The most common channel through which financial inclusion affects economic growth is through greater access to financial products and services offered by financial institutions that increases financial intermediation and translates to positive economic growth. The common empirical methodology used in the literature are causality tests, cointegration and regression methods. Multiple proxies of financial inclusion and economic growth were used in the literature which partly explains the conflicting result among existing studies. The review paper concludes by identifying some directions for future research.
    Keywords: financial inclusion, economic growth, literature review, access to finance, GDP, GDP per capita, causality tests, regression, cointegration, Africa, Europe, Asia, financial inclusion, index, theory.
    JEL: E30 E32 G21
    Date: 2023
  2. By: John Geanakoplos (Yale University)
    Abstract: Traditionally, booms and busts have been attributed to investors' excessive or insufficient demand, irrational exuberance and panics, or fraud. The leverage cycle begins with the observation that much of demand is facilitated by borrowing, and that crashes often occur simultaneously with the withdrawal of lending. Lenders are worried about default, and therefore attach credit terms like collateral or minimum credit ratings to their contracts. The credit surface, depicting interest rates as a function of the credit terms, emerges in leverage cycle equilibrium. Investors and lenders (and regulators) choose where on the credit surface they trade. The leverage cycle is about booms when credit terms, especially collateral, are chosen to be loose, and busts when they suddenly become tight, in contrast to the traditional fixation on the (riskless) interest rate. Leverage cycle crashes are triggered at the top of the cycle by scary bad news, which has three effects. The bad news reduces every agent's valuation of the asset. The increased uncertainty steepens the credit surface, causing credit terms to tighten on new loans, explaining the withdrawal of credit. The high valuation leveraged investors holding the asset lose wealth when the price falls; if their debts are due, they lose liquid wealth and face margin calls, and may be forced to sell their collateral. Each effect feeds back and exacerbates the others, and increases uncertainty. The credit surface is steeper for long loans than short loans because uncertainty is higher. Investors respond by borrowing short, voluntarily exposing themselves to margin calls. When uncertainty rises, the credit surface steepens more for low credit rating agents than for highly rated agents, leading to more inequality. The leverage cycle also applies to banks, leading to a theory of insolvency runs rather than panic runs. The leverage cycle policy implication for banks is that there should be transparency, which will induce depositors or regulators to hold down bank leverage before insolvency is reached. This is contrary to the view that opaqueness is a virtue of banks because it lessens panic.
    Date: 2022–01–31
  3. By: Mirela Sorina Miescu; Giorgio Motta; Dario Pontiggia; Raffaele Rossi
    Abstract: This paper studies the macroeconomic effects of exogenous changes in housing credit supply. We identify the credit supply shock with a narrative dataset within a Factor-Augmented VAR. We find that a housing credit supply shock is expansionary in the housing sector, the financial markets as well as on main macroeconomic indicators. A one percent increase in the housing credit supply expands Industrial Production up to 1.4 percent and reduces the unemployment rate by 0.4 percentage points.We show that controlling for missing information and anticipation effects is crucial for evaluating the transmission mechanism of housing credit supply shocks on the macroeconomy.
    Keywords: Credit Supply Shocks, Mortgage Markets, Factor Augmented VAR
    JEL: E44 E52 G28
    Date: 2023
  4. By: Marcio Santetti
    Abstract: This paper empirically assesses predictions of Goodwin's model of cyclical growth regarding demand and distributive regimes when integrating the real and financial sectors. In addition, it evaluates how financial and employment shocks affect the labor market and monetary policy variables over six different U.S. business-cycle peaks. It identifies a parsimonious Time-Varying Vector Autoregressive model with Stochastic Volatility (TVP-VAR-SV) with the labor share of income, the employment rate, residential investment, and the interest rate spread as endogenous variables. Using Bayesian inference methods, key results suggest (i) a combination of profit-led demand and profit-squeeze distribution; (ii) weakening of these regimes during the Great Moderation; and (iii) significant connections between the standard Goodwinian variables and residential investment as well as term spreads. Findings presented here broadly conform to the transition to increasingly deregulated financial and labor markets initiated in the 1980s.
    Date: 2023–10
  5. By: Nell, Kevin
    Abstract: This paper pays tribute to Professor Thirlwall’s substantive work in growth and development economics by providing a review of his book Inflation, Saving and Growth in Developing Economies (1974b) [hereafter ISGD]. Indeed, the hallmark of a good economics book is whether its theoretical content and empirical predictions made several decades ago remain relevant when assessed against more recent evidence. Thirlwall’s ISGD book exhibits all these qualities. It emphasises the importance of distinguishing between different types of inflation. Structural inflation and, to a lesser extent, cost inflation, should be seen as the inevitable outcomes of the growth and development process, whereas demand inflation may act as a direct stimulus to growth, as predicted by the Kaldor-Thirlwall model of forced saving and the inflation tax model. These theoretical insights remain highly relevant in today’s developing economies. Studies tend to show that inflation thresholds, up until the point where the effect of inflation on growth is positive, tend to be higher in developing economies relative to advanced countries, owing to a combination of structural, cost and demand-side sources of inflation. The analysis further argues that inflationary finance of development, as advanced in ISGD, remains a viable development strategy when open-economy constraints are considered.
    Keywords: Developing economies; inflation; investment; growth; saving; Thirlwall; threshold
    JEL: O11 O23 O47
    Date: 2023–09–01
  6. By: Nuwat Nookhwun; Rawipha Waiyawatjakorn
    Abstract: The experience of flexible inflation targeting in ASEAN-5 has been favorable. This paper shows improvements in macroeconomic outcomes consistent with the framework’s mandated objectives: lower levels and volatility of inflation, more stable economic growth and a well-functioned financial system. ASEAN-5 economies can cope well with a se- quence of past shocks and crises, although the marginal contribution of the inflation targeting framework itself is still not clear-cut. Over the past 20 years, policy frameworks of ASEAN-5, similar to other emerging market economies, have continuously evolved to incorporate various policy tools, which include foreign exchange intervention, macropru- dential policy and capital flow measures. This reflects challenges emanated from capital flow volatility and domestic financial imbalances. A multitude of policy tools are ar- guably one of the key factors contributing to the sound macroeconomic outcome during the post-targeting periods.
    Keywords: flexible inflation targeting; monetary policy; ASEAN; financial stability; integrated policy
    JEL: E52 E58 D78
    Date: 2023–10
  7. By: Aleksander Berentsen; Romina Ruprecht; Hugo van Buggenum
    Abstract: Major central banks remunerate reserves at negative rates (NIR). To study thelong-run effects of NIR, we focus on the role of reserves as intertemporal stores of value that are used to settle interbank liabilities. We construct a dynamic general equilibrium model with commercial banks holding reserves and funding investments with retail deposits. In the long run, NIR distorts investment decisions, lowers welfare, depresses output, and reduces bank profitability. The type of distortion depends on the transmission of NIR to retail deposits. The availability of cash explains the asymmetric effects of policy-rate changes in negative vs positive territory.
    Keywords: Monetary policy; Interest rates; Money market; Negative interest rate
    JEL: E40 E42 E43 E50 E58
    Date: 2023–09–29
  8. By: Priit Jeenas
    Abstract: I study the role of firms' balance sheet liquidity in the transmission of monetary policy to investment. In response to monetary contractions, U.S. firms with fewer liquid asset holdings reduce investment relatively more. This can be explained by their higher likelihood to issue debt and the implied exposure to borrowing cost fluctuations. I rationalize these results using a heterogeneous firm macroeconomic model with financial constraints, debt issuance costs, and differential returns on cash and borrowing. Compared to a framework which ignores liquidity considerations, monetary transmission to aggregate investment is slightly dampened and depends on liquid asset portfolios beyond net worth.
    Keywords: monetary policy, investment, financial frictions, firm heterogeneity
    Date: 2023–10
  9. By: Dusan Stojanovic
    Abstract: This study examines how and to what extent quantitative easing of the ECB affects household income and wealth inequality in the euro area. Previous theoretical models have investigated the dynamics of inequality measures through differential access of households to financial/capital market (the portfolio rebalancing channel), neglecting the labor market differential (the earnings heterogeneity channel). Although the portfolio rebalancing channel may provide insight into wealth inequality and non-labor income inequality, this is not the case with labor (and thus total) income inequality. To be in line with the empirical evidence on labor income inequality, this study also considers segmented labor market on the basis of capital-skill complementarity in production and asymmetric real wage rigidities. When only financial market segmentation is considered, the quantitative results indicate a drop in total income inequality that is diminished over time, while wealth inequality experiences a rise that gradually becomes weaker. The introduction of the segmented labor market significantly mitigates the observed drop in total income inequality, while a rise in wealth inequality is largely amplified. Given the possible broadening of the ECB’s mandate towards distributional issues in the future, the analysis of segmented labor and financial markets can be more beneficial to the ECB as it provides a clearer picture of the inequality effects.
    Keywords: quantitative easing, capital-skill complementarity, asymmetric real wage rigidity, skill premium, portfolio rebalancing channel, earnings heterogeneity channel
    JEL: E21 E22 E44 E52 E58
    Date: 2023–08
  10. By: Hites Ahir; Mr. Giovanni Dell'Ariccia; Davide Furceri; Mr. Chris Papageorgiou; Hanbo Qi
    Abstract: This paper uses text analysis to construct a continuous financial stress index (FSI) for 110 countries over each quarter during the period 1967-2018. It relies on a computer algorithm along with human expert oversight and is thus easy to update. The new indicator has a larger country and time coverage and higher frequency than similar measures focusing on advanced economies. And it complements existing binary chronologies in that it can assess the severity of financial crises. We use the indicator to assess the impact of financial stress on the economy using both country- and firm-level data. Our main findings are fivefold: i) consistent with existing literature, we show an economically significant and persistent relationship between financial stress and output; ii) the effect is larger in emerging markets and developing economies and (iii) for higher levels of financial stress; iv) we deal with simultaneous causality by constructing a novel instrument—financial stress originating from other countries—using information from the text analysis, and show that, while there is clear evidence that financial stress harms economic activities, OLS estimates tend to overestimate the magnitude of this effect; (iv) we confirm the presence of an exogenous effect of financial stress through a difference-in-differences exercise and show that effects are larger for firms that are more financially constrained and less profitable.
    Keywords: Financial stress; text analysis; country reports; continuous indicator; country and firm economic activity.
    Date: 2023–10–20
  11. By: Ali Namaki; Reza Eyvazloo; Shahin Ramtinnia
    Abstract: Early warning systems (EWSs) are critical for forecasting and preventing economic and financial crises. EWSs are designed to provide early warning signs of financial troubles, allowing policymakers and market participants to intervene before a crisis expands. The 2008 financial crisis highlighted the importance of detecting financial distress early and taking preventive measures to mitigate its effects. In this bibliometric review, we look at the research and literature on EWSs in finance. Our methodology included a comprehensive examination of academic databases and a stringent selection procedure, which resulted in the final selection of 616 articles published between 1976 and 2023. Our findings show that more than 90\% of the papers were published after 2006, indicating the growing importance of EWSs in financial research. According to our findings, recent research has shifted toward machine learning techniques, and EWSs are constantly evolving. We discovered that research in this area could be divided into four categories: bankruptcy prediction, banking crisis, currency crisis and emerging markets, and machine learning forecasting. Each cluster offers distinct insights into the approaches and methodologies used for EWSs. To improve predictive accuracy, our review emphasizes the importance of incorporating both macroeconomic and microeconomic data into EWS models. To improve their predictive performance, we recommend more research into incorporating alternative data sources into EWS models, such as social media data, news sentiment analysis, and network analysis.
    Date: 2023–09
  12. By: Takeo Hori (Department of Industrial Engineering and Economics, School of Engineering, Tokyo Institute of Technology); Ryonghun Im (School of Economics, Kwansei Gakuin University)
    Abstract: We present a simple model that yields qualitatively the same results as Miao and Wang (2018) and re-examine whether asset bubbles exist in their model. A positive feedback mechanism between stock price and endogenous credit constraints increases the stock price. However, we show that the increase in the stock price is not bubbles, but a part of the fundamental value of the stock.
    Keywords: asset bubbles, fundamental value, credit constraints
    JEL: E22 E44 G12
    Date: 2023–10
  13. By: Martin Feldkircher; Karin Klieber
    Abstract: This paper examines the degree of integration at euro area financial markets. To that end, we estimate overall and country-specific integration indices based on a panel vector-autoregression with factor stochastic volatility. Our results indicate a more heterogeneous bond market compared to the market for lending rates. At both markets, the global financial crisis and the sovereign debt crisis led to a severe decline in financial integration, which fully recovered since then. We furthermore identify countries that deviate from their peers either by responding differently to crisis events or by taking on different roles in the spillover network. The latter analysis reveals two set of countries, namely a main body of countries that receives and transmits spillovers and a second, smaller group of spillover absorbing economies. Finally, we demonstrate by estimating an augmented Taylor rule that euro area short-term interest rates are positively linked to the level of integration on the bond market.
    Date: 2023–10
  14. By: Wixforth, Harald
    Keywords: banks under governmental rule and control, credit economy, banking system Germany, economic constitution, Reichs-Kredit-Gesellschaft
    JEL: N23 N24 G21
    Date: 2023
  15. By: Liu, Yi
    Date: 2023
  16. By: Antonio Acconcis (University of Naples Federico II and CSEF); Daniela Fabbri (Bayes Business School, City University of London); Annamaria Menichini (Università di Salerno and CSEF)
    Abstract: Empirical literature documenting the real costs of financial crises links the surge of unemployment to mainly bank frictions. This paper takes a more comprehensive approach by looking at how bank credit constraints, firm’s capital structure and inputs characteristics interact in shaping the firms’s response. We document that both the firm’s ability to substitute bank with trade credit and the characteristics of the inputs transacted along the supply chain matter in shaping the labor market reaction of Italian corporations to the unfolding of the 2008-9 financial crisis. As bank lending conditions tightened, firms intensively increasing their reliance on trade credit managed to partly mitigate their employment contraction but faced a stronger input bias against labor. Manufacturing firms largely using trade credit to buy differentiated inputs experienced a smaller drop in employment but a stronger input bias than firms buying standardized inputs. Finally, while the labor market recovered quite fast for firms increasing their reliance on trade credit, with the number of employees reaching the pre-crisis level around 2016, the shift toward technologies less intensive in labor showed more persistence, with the input bias even sharpening during 2013-14 and being in 2019 still 6 percentage points higher than the initial 2008 value.
    Keywords: Bank financing, trade credit, employment, labor share.
    JEL: G32 G33 K22 L14
    Date: 2023–10–13
  17. By: Olayinka Oyekola (Department of Economics, University of Exeter); Meryem Duygun (Business School, University of Nottingham); Samuel Odewunmi (Department of Economics, University of Exeter); Temitope Fagbemi (Aberdeen Business School, Robert Gordon University)
    Abstract: Drawing on the strands of literature on agency theory, institutions and financial development, this paper investigates whether, and how, political risk can explain access to external finance by 127, 542 firms in 108 countries over the period 2006 to 2021. We do this by combining international firm-specific data with a globally representative political risk measure to explore variations in access to external finance for working capital and fixed investment by firms. Our results provide robust evidence of a strong positive impact of political risk on external finance. Specifically, we find that a one-standard-deviation increase in political risk leads to a 10.89% increase in access to external finance for working capital of sampled firms. We then examine which dimensions of political risk matter for external finance, finding that bureaucratic quality, corruption, government stability, socioeconomic conditions, investment profile, external conflict, and ethnic tensions are the relevant individual components. Further analyses show that the effects of political risk on external finance for working capital are amplified for firms that are either experiencing low growth, innovative, in the service sector, or small- and medium-sized enterprises. Our results survive a battery of robustness checks, including an alternative proxy for external finance (fixed investment), controlling for additional confounding factors and outliers. Given the central importance of firms as engines of growth, our paper makes an insightful contribution to the literature on the institutional determinants of access to entrepreneurial financing by firms.
    Keywords: political risk, institutions, access to finance, external finance, working capital, firm-level evidence
    JEL: G20 G30 O16 O50 L26
    Date: 2023–10–01

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