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on Financial Development and Growth |
| By: | Norman Loayza (The World Bank); Amine Ouazad (HEC Montreal); Romain Ranciere (University of Southern California) |
| Abstract: | This paper reviews the evolving literature that links financial development, financial crises, and economic growth in the past 20 years. The initial disconnect—with one literature focusing on the effect of financial deepening on long-run growth and another studying its impact on volatility and crisis—has given way to a more nuanced approach that analyzes the two phenomena in an integrated framework. The main finding of this literature is that financial deepening leads to a trade-off between higher economic growth and higher crisis risk; and its main conclusion is that, for at least middle-income countries, the positive growth effects outweigh the negative crisis risk impact. This balanced view has been revisited recently for advanced economies, where an emerging and controversial literature supports the notion of "too much finance," suggesting that there might be a threshold beyond which financial depth becomes detrimental for economic growth by crowding out other productive activities and misallocating resources. Nevertheless, the growth/crisis trade-off is alive and strong for a large share of the world economy. Recognizing the intrinsic trade-offs of financial development can provide a useful framework to design policies targeting financial deepening, diversity, and inclusion. In particular, acknowledging the trade-offs can highlight the need for complementary policies to mitigate the risks, from financial macroprudential policies to monetary policy frameworks that monitor the growth of credit and asset prices. |
| Keywords: | Finance, Financial Deepening, Development, Growth, Productivity, Crisis, Volatility, Risk, Macroprudential Policies |
| JEL: | E44 O40 G00 G01 G32 H12 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:apc:wpaper:2017-114&r=fdg |
| By: | Mikael Juselius (Bank of FInland); Anton Korinek (Johns Hopkins University); Mathias Drehmann (Bank for International Settlements) |
| Abstract: | This paper documents the main channel through which credit booms affect real economic activity in the future. As a matter of simple accounting, credit booms generate a predictable increase in future debt service that transfers spending power from borrowers to lenders. We document this dynamic pattern in a panel of 17 countries from 1980 to 2015 and identify a robust lead-lag relationship of about 3 years between the peak of credit booms and the peak in debt service. We develop a method to decompose what fraction of future real effects of credit booms is explained by debt service and show that debt service almost fully accounts for several puzzling findings in the recent empirical literature: that high growth in credit predicts low output growth in the future, deeper recessions, and a greater likelihood of financial crises. Explicitly accounting for debt service not only sheds light on the channel behind these findings but also generates stronger empirical relationships. We hope that our results will provide useful guidance for future efforts to model credit cycles. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1258&r=fdg |
| By: | de Ridder, Maarten |
| Abstract: | This paper analyzes the channels through which financial crises exert long-term negative effects on output. Recent models suggest that a shortfall in productivity-enhancing invest- ments temporarily slows technological progress, creating a gap between pre-crisis trend and actual GDP. This hypothesis is tested using a linked lender-borrower dataset on 519 U.S. corporations responsible for 54% of industrial research and development. Exploiting quasi-experimental variation in firm-level exposure to the 2008-9 financial crisis, I show that tight credit reduced investments in productivity-enhancement, and has significantly slowed down output growth between 2010 and 2015. A partial-equilibrium aggregation exercise suggests output would be 12% higher today if productivity-enhancing investments had grown at pre-crisis rates. |
| Keywords: | Financial crises; endogenous growth; innovation; business cycles |
| JEL: | E32 E44 O30 O47 |
| Date: | 2016–09–30 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86180&r=fdg |
| By: | Lehmann-Hasemeyer, Sibylle; Wahl, Fabian |
| Abstract: | We show that smaller, regional public financial intermediaries significantly contributed to industrial development, using a new data set of the foundation year and location of Prussian savings banks. This extends the banking-growth nexus beyond its traditional focus on the large universal banks, to savings banks. The saving banks had an impact through the financing of public infrastructure, such as railways, and new private factories. Saving banks were public financial intermediaries, so our results suggest that state intervention can be successful, particularly at early stages of industrial development when capital requirements are manageable, and access to international capital markets is limited. |
| Keywords: | Industrialisation; Prussia; Public Infrastructure; Regional and Urban Development; Savings Banks |
| JEL: | G21 N23 N74 N93 R11 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12500&r=fdg |
| By: | Imad Hamma (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - CNRS - Centre National de la Recherche Scientifique - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - UCA - Université Côte d'Azur) |
| Abstract: | This paper seeks to examine the effect of remittances on economic growth in Middle East and North Africa (MENA) countries. Using unbalanced panel data covering a sample of 12 MENA countries over the period 1984-2012, we studied the hypothesis that the effect of remittances on economic growth varies depending on the level of financial development and institutional environment in recipient countries. We use GMM estimation in which we address the endogeneity of remittances. Our results reveal a complementary relationship among financial development and remittances to ensure economic growth. The estimations also show that remittances promote growth in countries with a developed financial system and a strong institutional environment. |
| Date: | 2016–12–02 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01655353&r=fdg |
| By: | Cui, Wei; Kaas, Leo |
| Abstract: | Recessions are often accompanied by spikes of corporate default and prolonged declines of business credit. This paper argues that credit and default cycles are the outcomes of variations in self-fulfilling beliefs about credit market conditions. We develop a tractable macroeconomic model in which leverage ratios and interest spreads are determined in optimal credit contracts that reflect the expected default risk of borrowing firms. We calibrate the model to evaluate the impact of sunspots and fundamental shocks on the credit market and on output dynamics. Self-fulfilling changes in credit market expectations trigger sizable reactions in default rates and generate endogenously persistent credit and output cycles. All credit market shocks together account for about 50% of the variation of U.S. output growth during 1982–2015. |
| Keywords: | Firm default; Financing constraints; Credit Spreads; Sunspots growth; population. |
| JEL: | E22 E32 E44 G12 |
| Date: | 2017–05 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86159&r=fdg |
| By: | Piyabha Kongsamut; Christian Mumssen; Anne-Charlotte Paret; Thierry Tressel |
| Abstract: | How can information on financial conditions be used to better understand macroeconomic developments and improve macroeconomic projections? We investigate this question for France by constructing country-specific financial conditions indices (FCIs) that are tailored to movements in GDP, investment, private consumption and exports respectively. We rely on a VAR approach to estimate the weights of the financial components of each FCI, including equity market returns (which turn out having a relatively strong weight across all FCIs), private sector risk premiums, long-term interest rates, and banks’ credit standards. We find that the tailored FCIs are useful as leading indicators of GDP, investment, and exports, and as a contemporaneous indicator of private consumption. Credit volumes turn out to be lagging indicators of growth. The indices inform us on macro-financial linkages in France and are used to improve the accuracy of quarterly forecasting models and high-frequency “nowcast” models. We show that FCI-augmented models could have significantly improved forecasts during and after the global financial crisis. |
| Date: | 2017–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:17/269&r=fdg |
| By: | Nina Boyarchenko (Federal Reserve Bank of New York); Domenico Giannone (Federal Reserve Bank of New York); Tobias Adrian (Federal Reserve Bank of New York) |
| Abstract: | We study the conditional distribution of GDP growth as a function of economic and financial conditions. Deteriorating financial conditions are associated with an increase in conditional volatility and a decline in the conditional mean of GDP growth, leading to a highly skewed distribution, with the lower quantiles of GDP growth exhibiting strong variation as a function of financial conditions and the upper quantiles stable over time. While measures of financial conditions significantly forecast downside vulnerability, measures of economic conditions have significant predictive power only for the median of the distribution. These findings are robust both in- and out-of-sample and to using different measures of financial conditions. We quantify GDP vulnerability as the relative entropy between the conditional and unconditional distribution. We show that this measure of vulnerability is highly asymmetric: the contribution to the total relative entropy of the probability mass below the median of the conditional distribution is larger and more volatile than the contribution of the probability mass above the median. The asymmetric response of the distribution of GDP growth to financial and economic conditions -- with adverse financial conditions increasing downside vulnerability of growth but not the median forecast -- is challenging for standard models of the macroeconomy. We argue that the inclusion of a financial sector is crucial for generating the observed dynamics of growth vulnerability. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1317&r=fdg |