Financial Development, Financial Fragility, and Growth

Abstract

This paper studies the apparent contradiction between two strands of the literature on the effects of financial intermediation on economic activity. On the one hand, the empirical growth literature finds a positive effect of financial depth as measured by, for instance, private domestic credit and liquid liabilities (e.g., . On the other hand, the banking and currency crisis literature finds that monetary aggregates, such as domestic credit, are among the best predictors of crises and their related economic downturns (e.g., Kaminski and Reinhart 1999). The paper accounts for these contrasting effects based on the distinction between the short-and long-run impacts of financial intermediation. Working with a panel of cross-country and time-series observations, the paper estimates an encompassing model of short-and long-run effects using the Pooled Mean Group estimator developed by Pesaran, Shin, and Smith (1999). The conclusion from this analysis is that a positive long-run relationship between financial intermediation and output growth co-exists with a, mostly, negative short-run relationship. The paper further develops an explanation for these contrasting effects by relating them to recent theoretical models, by linking the estimated short-run effects to measures of financial fragility (namely, banking crises and financial volatility), and by jointly analyzing the effects of financial depth and fragility in classic panel growth regressions.

Tariffs and economic growth in the first era of globalization

“…Short-term heterogeneity in the growth processes between countries would not come as a surprise to many economic historians, but the problem has also attracted considerable attention in the more recent literature. Recent applications of the mean group and pooled mean group estimators in the growth context include Lee et al (1998), Bassanini and Scarpetta (2002), Loayza and Ranciere (2006) as well as Tan (2009). In our context, pooled mean group estimation carries an additional advantage as it enables us to distinguish between short-run and long-run effects of tariff protection.…”

Institutions and the finance–growth nexus: Empirical evidence from MENA countries

“…To investigate the finance and growth relationship, Loayza and Ranciere (2006) and Demetriades and Law (2006) adopted the Pooled Mean Group (PMG) estimators proposed by Pesaran, Yongcheol, and Ron (1999) with its advantage of controlling for country heterogeneity in the financeegrowth nexus. Using a sample of 75 countries and annual data for the period from 1960 to 2000 and based on the PMG estimator, Loayza and Ranciere (2006) found that while financial intermediation had a positive and significant effect on economic growth in the long run, this effect was significantly negative in the short run.…”

Relationship Between Financial and Real Sectors: Implications for Stable Economic Development (Evidence from Thailand)

“…Kaminsky and Reinhart (1999) found that channels of financial development have plausible negative effect on economic development by triggering instabilities in financial sector. Because of financial instabilities, a positive long-run relationship exist among output and financial intermediation, whereas in short-run the relationship becomes negative (Loayza & Ranciere, 2006). Rousseau and Wachtel (2011) explain that irrespective of country's stage of development, a positive impact of financial growth get weakens with the passage of time.…”