nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2024‒01‒01
24 papers chosen by
Georg Man,

  1. Supply-leading or demand-following financial sector and economic development nexus: evidence from data-rich Indonesia By Mansur, Alfan; Nizar, Muhammad Afdi
  2. Economic growth, income distribution, and financial system: an analysis based on financial social accounting matrices for the brazilian economy By Juliana Rodrigues Vieira; Gilberto de Assis Libânio; Débora Freire Cardoso
  3. Income Share of the Top 10%, the Middle 50% and the Bottom 40% in Latin America: 1920-2011 By Pablo Astorga
  4. When Credit Expansions Become Troublesome: The Story of Investor Sentiments By Poeschl, Johannes; Gerba, Eddie; Leiva-Leon, Danilo
  5. Doombot: a machine learning algorithm for predicting downturns in OECD countries By Thomas Chalaux; David Turner
  6. Loan-to-Value Shocks and Housing in the Production Function By Vivek Sharma
  7. The Impact of Commercial Real Estate Regulations on U.S. Output By Fil Babalievsky; Kyle F. Herkenhoff; Lee E. Ohanian; Edward C. Prescott
  8. One-Sided Limited Commitment and Aggregate Risk By Yoshiki Ando; Dirk Krueger; Harald Uhlig
  9. A Financial New Keynesian Model By Thomas M. Mertens; Tony Zhang
  10. Structural reforms and economic performance: the experience of advanced economies By Campos, Nauro F.; De Grauwe, Paul; Ji, Yuemei
  11. Is Debt Always Harmful for Economic Growth? Evidence from Developing Countries By Mara Leticia Rojas; María María Ibáñez Martín; Carlos Dabús
  12. What Lessons Can Be Drawn from Japan’s High Debt-to-GDP Ratio? By YiLi Chien; Ashley Stewart
  13. “Sovereign Risk and Economic Complexity: Machine Learning Insights on Causality and Prediction†By Jose E. Gomez-Gonzalez; Jorge M. Uribe; Oscar M. Valencia
  14. Local Currency Sovereign Debt Markets, Global Financial Conditions and the Role of Foreign Investors By Guilherme Suedekum
  15. Does Monetary Policy Affect Non-mining Business Investment in Australia? Evidence from BLADE By Gulnara Nolan; Jonathan Hambur; Philip Vermeulen
  16. Imperfect Information and Hidden Dynamics By Paul Levine; Maryam Mirfatah; Joseph Pearlman; Stylianos Tsiaras
  17. Is FinTech Eating the Bank's Lunch? By Sami Ben Naceur; Bertrand Candelon; Mr. Selim A Elekdag; Drilona Emrullahu
  18. Central Bank Digital Currency and Bank Disintermediation in a Portfolio Choice Model By Huifeng Chang; Federico Grinberg; Lucyna Gornicka; Mr. Marcello Miccoli; Brandon Tan
  19. Contagious Stablecoins By van Buggenum, Hugo; Gersbach, Hans; Zelzner, Sebastian
  20. Taming Financial Dollarization: Determinants and Effective Policies – The Case of Uruguay By Mr. Mauricio Vargas; Jesus Sanchez
  21. Implications of Asset Market Data for Equilibrium Models of Exchange Rates By Zhengyang Jiang; Arvind Krishnamurthy; Hanno Lustig
  22. Financial transaction taxes and the informational efficiency of financial markets: a structural estimation By Cipriani, Marco; Guarino, Antonio; Uthemann, Andreas
  23. European banking in transformational times: Regulation, crises, and challenges By Koetter, Michael; Nguyen, Huyen
  24. The Nonbank Shadow of Banks By Nicola Cetorelli; Saketh Prazad

  1. By: Mansur, Alfan; Nizar, Muhammad Afdi
    Abstract: Supply-leading theory predicts that the financial sector development precedes economic development while demand-following theory believes that the economy should develop, then the financial sector follows. This study exploits the financial sector and economic development relationship in a data-rich environment. Besides the depth, financial access and efficiency are also vital in the financial sector development. We employ a FAVAR model using 22 financial development indicators and 12 economic variables of the monthly Indonesian data series 2015M1-2023M6. Our empirical results reveal the bi-causal relationships between the financial sector and economic development. Then, whether the relationship is more demand-following or supply-leading depends on the measures used and the time trajectory. While an expansion in real GDP seems to have a more persistent impact on the development of financial institutions such as the banking and insurance sectors (demand-following relationship), the supply-leading relationship is influential in the short run. We also find that boosting access to credit and both stock and bond markets provokes economic activities. In addition, the increasing usage of electronic money encourages more consumption of imported goods than domestic goods.
    Keywords: financial sector, economic activities, demand, supply, FAVAR
    JEL: C11 C38 C55 E44 G10 G18 G21 G28
    Date: 2023–11–10
  2. By: Juliana Rodrigues Vieira (BDMG); Gilberto de Assis Libânio (UFMG); Débora Freire Cardoso (UFMG)
    Abstract: This study analyzes the relationship between income distribution, economic growth, and the financial system for the Brazilian economy from 2005 to 2017. Our main goal is to investigate the role of the financial sector in explaining economic growth and the distributive structure. In terms of methodology, this work is based on the social accounting model, via the estimation of social accounting multipliers. These were obtained from financial social accounting matrices for the years 2005, 2008 and 2017. Our results suggest that the financial sector has contributed to economic growth and agents’ income. However, it has also brought about negative effects on income distribution, due to the unequal access to financial products across income deciles – which highlights the importance of policies aimed at facilitating access to the financial sector by lower income individuals.
    Keywords: income distribution, economic growth, financial system
    JEL: O11 O47 N20
    Date: 2023–12
  3. By: Pablo Astorga (Institut Barcelona d’Estudis Internacionals (IBEI))
    Abstract: This paper analyses, for the first time, comparable income shares of the top 10%, the middle 50% and the bottom 40% of the labour force in Argentina, Brazil, Chile, Colombia, Mexico and Venezuela (LA6) from 1920 to 2011 using a new dataset. The main findings are: i) over the whole period the LA6 exhibited a recurrent very high income concentration at the top 10% (an average share of 48.1%) and a relatively low share for those of the bottom 40% (13.9%), with a Palma ratio of 3.5; ii) although the three shares varied over time and showed important differences across countries and developmental epochs, the region largely missed the Great Levelling experienced by the US and the UK during the middle decades of the last century; iii) there is no support over time for the “Palma proposition” stating a relative stability of the income share of the middle 50%. Despite policy efforts in the 2000s to raise the income of the bottom 40%, altogether, a more equitable income distribution is still a pending task in Latin America.
    Keywords: economic development, industrialisation, income inequality, Latin America
    JEL: O10 N1 O15 O54
    Date: 2023–11
  4. By: Poeschl, Johannes; Gerba, Eddie; Leiva-Leon, Danilo
    JEL: E44 G24 G28
    Date: 2023
  5. By: Thomas Chalaux; David Turner
    Abstract: This paper describes an algorithm, “DoomBot”, which selects parsimonious models to predict downturns over different quarterly horizons covering the ensuing two years for 20 OECD countries. The models are country- and horizon-specific and are automatically updated as the estimation sample period is extended, so facilitating out-of-sample evaluation of the algorithm. A limited combination of explanatory variables is chosen from a much larger pool of potential variables that include those that have been most useful in predicting downturns in previous OECD work. The most frequently selected variables are financial variables, especially those relating to credit and house prices, but also include equity prices and various measures of interest rates (such as the slope of the yield curve). Business cycle variables -- survey measure of capacity utilisation, industrial production, GDP and unemployment -- are also selected, but more frequently at very short horizons. The variables selected do not just relate to the domestic economy of the country being considered, but also international aggregates, consistent with findings from previous OECD work. The in-sample fit of the models is very good on standard performance metrics, although the out-of-sample performance is less impressive. The models do, however, provide a clear out-of-sample early warning of the Global Financial Crisis (GFC), especially when considered collectively, although they do generate ‘false alarms’ just ahead of the crisis. The models are less good at predicting the euro area crisis out-of-sample, but it is clear from the evolution of the choice of variables that the algorithm learns from this episode, for example through the more frequent selection of a variable measuring euro area sovereign bond spreads. The latest out-of-sample predictions made in mid-2023, suggest the probability of a downturn is at its greatest and most widespread since the GFC, with the largest contributions to such risks coming from house prices, interest rate developments (as measured by the slope of the yield curve and the rapidity of the change in short rates) and oil prices. On the other hand, warning signals from business cycle variables and equity prices, which are often good downturn predictors at short horizons, are conspicuously absent.
    Keywords: Downturn, forecast, GDP growth, recession, risk
    JEL: E01 E17 E65 E66 E58
    Date: 2023–12–12
  6. By: Vivek Sharma
    Abstract: Using a Two-Agent RBC model with time-varying shock to loan-to-value (LTV) ratios, I show that including housing (real estate or land) in the entrepreneurial production function has profound implications for results. In a model in which housing does not play a role as a production input, an LTV tightening has starkly different effects compared to a model in which it is a factor in the production process. In a setup devoid of a role for housing as a production input, differently from the results in the current literature, an LTV tightening leads to a spike in housing price at impact and a lesser fall afterwards. Other macroeconomic variables such as investment and output fall more at lower initial LTV ratios than at higher steady state LTV ratios. The findings of this paper indicate that housing plays an important role in shaping macroeconomic effects of LTV shocks.
    Keywords: Loan-to-Value (LTV) Shocks, Housing in the Production Function, Macroeconomic Fluctuations
    JEL: E32 E44
    Date: 2023–11
  7. By: Fil Babalievsky; Kyle F. Herkenhoff; Lee E. Ohanian; Edward C. Prescott
    Abstract: Commercial real estate accounts for roughly 20% of the U.S. fixed asset stock, and commercial land use is highly regulated. However, little is known about the quantitative impact of these regulations on economic activity or consumer welfare. This paper develops a spatial general equilibrium model of the U.S. economy that includes commercial real estate regulations and congestion effects, the latter of which provide a rationale for such regulations. The model is tailored to exploit the near-universe of CoreLogic's commercial, parcel-level, property tax records to construct a quantitative index of commercial real estate regulations for nearly every commercial property. We use the model to evaluate the positive and normative impacts of commercial land use deregulations. Moderately relaxing commercial regulations across all U.S. cities yields large allocative efficiency effects, with output gains of about 3 percent to 6 percent and welfare gains of about 3 percent to 9 percent of lifetime consumption. We also find significant positive and normative gains from deregulation with 40 percent of the labor force working remotely.
    JEL: E02 K2 R2 R3
    Date: 2023–11
  8. By: Yoshiki Ando; Dirk Krueger; Harald Uhlig
    Abstract: In this paper we study the neoclassical growth model with idiosyncratic income risk and aggregate risk in which risk sharing is endogenously constrained by one-sided limited commitment. Households can trade a full set of contingent claims that pay off depending on both idiosyncratic and aggregate risk, but limited commitment rules out that households sell these assets short. The model results, under suitable restrictions of the parameters of the model, in partial consumption insurance in equilibrium. With log-utility and idiosyncratic income shocks taking two values one of which is zero (e.g., employment and unemployment) we show that the equilibrium can be characterized in closed form, despite the fact that it features a non-degenerate consumption- and wealth distribution. We use the tractability of the model to study, analytically, inequality over the business cycle and asset pricing, and derive conditions under which our model has identical, as well as conditions under which it has lower/higher risk premia than the corresponding representative agent version of the model.
    JEL: D15 D31 E21 E23
    Date: 2023–11
  9. By: Thomas M. Mertens; Tony Zhang
    Abstract: This paper solves a standard New Keynesian model in terms of risk-neutral expectations and estimates it using a cross-section of longer-dated financial assets at a single point in time. Inflation risk premia appear in the theory and cause inflation to deviate from its target on average. We re-estimate the model based on each day’s closing prices to capture high-frequency changes in the expected path of the economy. Our estimates show that financial markets reacted to the post-COVID surge in inflation with higher short-run inflation expectations, an increase in the inflation risk premium, and an increase in the long-run neutral real rate, 𝑟∗, while long-term inflation expectations remained well anchored. Our model produces long term inflation forecasts that outperform several standard alternative measures.
    Keywords: Keynesian models; financial markets; covid19; inflation forecasts
    Date: 2023–11–13
  10. By: Campos, Nauro F.; De Grauwe, Paul; Ji, Yuemei
    Abstract: This paper provides a comprehensive assessment of the theoretical and empirical literature on structural reforms in advanced economies. Structural reforms matter because they entail profound and systematic changes that affect economic welfare, productivity, growth, unemployment, macroeconomic stability, and income inequality. Here we focus on structural reforms in product, labor, and financial markets. After putting forward a set of stylized facts, we take stock of the literature on each of these three key structural reforms, and then assess their business cycle and political economy implications. We underscore various gaps in the literature and articulate a future research agenda that highlights four main areas: measurement, interactions among reforms, political economy considerations, and the timing of the implementation of reforms.
    Keywords: structural reforms; economic performance; product market reforms; labor market reforms; financial market reforms; ES/P000274/1
    JEL: E23 D72 H26 O17
    Date: 2023–11–12
  11. By: Mara Leticia Rojas (UNS-CONICET); María María Ibáñez Martín (UNS-CONICET); Carlos Dabús (UNS-CONICET)
    Abstract: The debate on damage risks of high levels of debt on long run economic performance is not new. Nonetheless, this has achieved increasing interest during the last decades because of several countries and regions have acquired high indebtedness, particularly those with doubtful capacity of repayment. The study of a non-linear relationship between both macroeconomic variables and the value (or values) at which the incidence of debt could change sign at said threshold are relevant issues for the performance of economies, the economic policy and, even, the debt payment. This paper uses a panel threshold regression model, with initial real per capita GDP and debt-to-exports ratio as threshold variables, in order to prove heterogeneous effects of debt on growth in developing countries. The results show that the effect of debt depends on both threshold variables. Higher levels of initial GDP are related to negative effects of debt on growth, the relation between debt and growth tends to be insignificant for medium values and exhibits a positive relation to low values of product. Furthermore, debt-to-exports ratio exhibits a single turning point beyond which debt seems to be harmed for economic growth. The level of those thresholds is also estimated.
    JEL: O5 E60
    Date: 2023–12
  12. By: YiLi Chien; Ashley Stewart
    Abstract: Taking into account other public liabilities and assets can provide a clearer picture when comparing Japan’s debt-to-GDP ratio with that of the U.S.
    Keywords: Japan; debt-to-GDP ratio
    Date: 2023–11–14
  13. By: Jose E. Gomez-Gonzalez (City University of New York-Lehman College (USA). Visiting Professor - Universidad de la Sabana); Jorge M. Uribe (Universitat Oberta de Catalunya, Barcelona (Spain)); Oscar M. Valencia (Fiscal Management Division, Inter-American Development Bank, Washington (USA).)
    Abstract: We investigate how a country’s economic complexity influences its sovereign yield spread with respect to the US. We analyze various maturities across 28 countries, consisting of 16 emerging and 12 advanced economies. Notably, a one-unit increase in the economic complexity index is associated to a reduction of about 87 basis points in the 10-year yield spread (p
    Keywords: Sovereign Credit Risk, Convenience Yields, Yield Curve, Government Debt, Double-Machine-Learning, XGBoost. JEL classification: F34, G12, G15, H63, O40.
    Date: 2023–11
  14. By: Guilherme Suedekum (IHEID, Graduate Institute of International and Development Studies, Geneva)
    Abstract: This paper studies how the presence of foreign investors in local currency sovereign debt markets contributes to the transmission of global financial conditions to emerging market economies. My estimations indicate that the higher the share of local currency government bonds held by foreign investors, the more sensitive the credit risk of these bonds becomes to global financial shocks. When foreign investors’ holdings reach 45 percent, the credit risk of local currency government bonds becomes as sensitive to global financial shocks as the credit risk of foreign currency government bonds. I also explore exogenous foreign investor outflows caused by an unanticipated announcement of country weight rebalancing in the J.P. Morgan GBI-EM Global Diversified index in March 2014. Countries that experienced foreign investor outflows also experienced a decrease in the sensitivity of their local currency sovereign debt markets to changes in global financial conditions.
    Keywords: Emerging Market Economies; Local Currency Sovereign Debt; Credit Risk; Global Financial Conditions
    JEL: F34 G15 H63
    Date: 2023–11–30
  15. By: Gulnara Nolan (Reserve Bank of Australia); Jonathan Hambur (Reserve Bank of Australia); Philip Vermeulen (University of Canterbury, New Zealand)
    Abstract: We provide new evidence on the effect of monetary policy on investment in Australia using firm-level data. We find that contractionary monetary policy makes firms less likely to invest and lowers the amount they invest if they do so. The effects are similar for young and old firms, indicating that the decline in the number of young firms in Australia over time is unlikely to have weakened the effect of monetary policy. The effects are also broadly similar for smaller and larger firms. This suggests that evidence that some, particularly large, firms have sticky hurdle rates does not mean that they do not respond to monetary policy. It also suggests that overseas findings that expansionary monetary policy lessens competition by supporting the largest firms likely do not apply to Australia. We find evidence that financially constrained firms, and sectors that are more dependent on external finance, are more responsive to monetary policy, highlighting the important role of cash flow and financing constraints in the transmission of monetary policy. Finally, we find evidence that monetary policy affects firms' actual and expected investment contemporaneously, suggesting that expectations are reactive and will tend to lag over the cycle.
    Keywords: investment; monetary policy; financial constraints
    JEL: E22 E52
    Date: 2023–12
  16. By: Paul Levine (University of Surrey); Maryam Mirfatah (King’s College London); Joseph Pearlman (City University); Stylianos Tsiaras (Ecole Polytechnique Federale de Lausanne)
    Abstract: We study central bank liquidity provisions to the banking sector in a DSGE model estimated for the Euro Area with financial frictions on the supply and demand side of credit. We show that liquidity provisions, as in the ECB’s recent Long Term Refinancing Operations, can be welfare-enhancing or welfare-reducing when both these financial frictions exist. They relax the banks’ leverage constraint and induce banks to provide more credit. This reduces the credit spread facing firms and increases investment, but this comes at the cost of implementing the liquidity policy. We compute a welfare optimized liquidity rule for the central bank responding to output, inflation and the interest rate spread that can increase welfare in comparison with the case of no liquidity provision. Crucially, this result is conditional on a high level of central bank monitoring of the its loanable funds to banks.
    JEL: C11 E44 E52 E58 E61
    Date: 2023–11
  17. By: Sami Ben Naceur; Bertrand Candelon; Mr. Selim A Elekdag; Drilona Emrullahu
    Abstract: This paper examines how the growing presence of FinTech firms affects the performance of traditional financial institutions. The findings point to a negative impact on profitability, primarily due to a reduction in interest income and a rise in operational costs. Although established financial institutions have tried to diversify their revenue streams, these efforts have proven inadequate to offset the losses associated with increased competition from FinTech firms. Our study also reveals that various FinTech business models, such as Peer-to-Peer (P2P) lending and Balance Sheet lending, have varying effects on financial institutions. Cooperative banks experience more significant profit deterioration under both models, whereas (larger) commercial banks appear to benefit from partnerships with P2P platforms, as evidenced by an increase in non-interest income. Furthermore, the findings suggest that FinTech presence has a disproportionately larger adverse effect on banks in countries with more competitive, profitable, and developed financial systems. Interestingly, however, traditional financial institutions in countries with stronger regulatory frameworks appear to benefit from the expanding influence of FinTech firms.
    Keywords: fintech; bank profitability; competition; business models
    Date: 2023–11–17
  18. By: Huifeng Chang; Federico Grinberg; Lucyna Gornicka; Mr. Marcello Miccoli; Brandon Tan
    Abstract: Would the introduction of a Central Bank Digital Currency (CBDC) lead to lower deposits (disintermediation) and lending in the banking sector? This paper develops a model where households heterogeneous in wealth allocate between an illiquid asset and assets that can be used for payments: bank deposits, cash, and CBDC. CBDC is more efficient as a means of payment and has lower access cost than deposits. Deposits are offered by an imperfectly competitive banking sector which raises deposit interest rates after CBDC introduction to prevent substitution away from deposits to CBDC. We find that there are two opposing margins of impact on the level of aggregate deposits: (1) the intensive margin gain in deposits by richer households increasing their holdings of deposits because of higher interest rates, and (2) the extensive margin loss of deposits among poorer households who switch from deposits to the CBDC. The extensive margin loss in deposits is more likely to dominate (yielding a fall in aggregate deposits) when the mass of poorer households is large and when it is relatively costly to access bank accounts. This tends to be the case in developing and emerging market economies. However, even when the extensive margin loss of deposits dominates and there is disintermediation, the impact on lending is quantitatively small if banks have access to other forms of funding, such as wholesale or central bank financing.
    Keywords: CBDC; banking disintermediation; financial inclusion; monetary policy
    Date: 2023–11–17
  19. By: van Buggenum, Hugo; Gersbach, Hans; Zelzner, Sebastian
    JEL: E4 E5 G1 G2
    Date: 2023
  20. By: Mr. Mauricio Vargas; Jesus Sanchez
    Abstract: With some of the most significant levels of financial dollarization in the Western Hemisphere, Uruguay is characterized by extensive dollarization in both deposits and loans. While traditional factors like high inflation and substantial devaluations have been associated with such outcome, the enduring nature of dollarization in Uruguay also underscores the importance of structural elements. In formulating a holistic strategy to reduce dollarization, not only should there be an enhancement of the monetary policy framework aimed at maintaining low, stable inflation, but it should also consider the calibration of prudential policies such as currency-differentiated reserve requirements and foreign-currency credit repos.
    Keywords: Dollarization; Prudential Policies; Monetary Policy; Uruguay; Peru.
    Date: 2023–11–24
  21. By: Zhengyang Jiang; Arvind Krishnamurthy; Hanno Lustig
    Abstract: We characterize the relation between exchange rates and their macroeconomic fundamentals without committing to a specific model of preferences, endowment or menu of traded assets. When investors can trade home and foreign currency risk-free bonds, the exchange rate appreciates in states that are worse for home investors than foreign investors. This prediction is at odds with the empirical evidence and can only be overturned if the deviations from U.I.P. are large and exchange rates are highly predictable. Without bond Euler equation wedges, it is impossible to match the empirical exchange rate cyclicality (the Backus-Smith puzzle) and the deviations from U.I.P. (the Fama puzzle) as well as the lack of predictability (the Meese-Rogoff puzzle). To relax this trade-off, we need Euler equation wedges consistent with a home currency bias, home bond convenience yields or financial repression.
    JEL: F31 G12
    Date: 2023–11
  22. By: Cipriani, Marco; Guarino, Antonio; Uthemann, Andreas
    Abstract: We develop a new methodology to estimate the impact of a financial transaction tax (FTT) on financial market outcomes. In our sequential trading model, there are price-elastic noise and informed traders. We estimate the model through maximum likelihood for a sample of 60 NYSE stocks in 2017. We quantify the effect of introducing an FTT given the parameter estimates. An FTT increases the proportion of informed trading, improves information aggregation, but lowers trading volume and welfare. For some less liquid stocks, however, an FTT blocks private information aggregation.
    Keywords: Financial transaction tax; Market microstructure; Structural estimation; ES/R009724/1; ES/K002309/1
    JEL: G14 D82 C13
    Date: 2022–12–01
  23. By: Koetter, Michael; Nguyen, Huyen
    Abstract: This paper assesses the progress made towards the creation of the European Banking Union (EBU) and the evolution of the banking industry in the European Union since the financial crisis of 2007. We review major regulatory changes pertaining to the three pillars of the EBU and the effects of new legislation on both banks and the real economy. Whereas farreaching reforms pertaining to the EBU pillars of supervision and resolution regimes have been implemented, the absence of a European Deposit Scheme remains a crucial deficiency. We discuss how European banks coped with recent challenges, such as the Covid-19 pandemic, a high inflation environment, and digitalization needs, followed by an outlook on selected major challenges lying ahead of this incomplete EBU, notably the transition towards a green economy.
    Date: 2023
  24. By: Nicola Cetorelli; Saketh Prazad
    Abstract: Financial and technological innovation and changes in the macroeconomic environment have led to the growth of nonbank financial institutions (NBFIs), and to the possible displacement of banks in the provision of traditional financial intermediation services (deposit taking, loan making, and facilitation of payments). In this post, we look at the joint evolution of banks—referred to as depository institutions from here on—and nonbanks inside the organizational structure of bank holding companies (BHCs). Using a unique database of the organizational structure of all BHCs ever in existence since the 1970s, we document the evolution of NBFI activities within BHCs. Our evidence suggests that there exist important conglomeration synergies to having both banks and NBFIs under the same organizational umbrella.
    Keywords: nonbank financial institutions (NBFIs); conglomeration; benefits; banks
    JEL: G2
    Date: 2023–11–27

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