Inflation and Financial Depth

Abstract

There is now a substantial theoretical literature arguing that inflation impedes financial deepening. Furthermore, it has been hypothesized that the relationship is a nonlinear one, in that there is a threshold level of inflation below which inflation has a positive effect on financial depth, but above which the effect turns negative. Using a large cross-country sample, empirical support is found for the existence of such a threshold. The estimates indicate that the threshold level of inflation is generally about 3–6 percent per annum, depending on the specific measure of financial depth that is utilized.

The Effect of Inflation on Financial Development Indicators in Iran (2000–2015)

“…According to Choi et al (1996) in higher rates of inflation efficiency savings reduces, information friction increases and consequently accumulation of funds for the financial system will reduces and Khan et al (2006) believes that this inflationary effect will be a long-term effect. On the other hand, theoretical models explain that higher rates of inflation, results in the dispersal of financial information flows and the rationing of credits to private sector and ultimately to exacerbate the gaps in credit markets.…”

“…Inflation is also associated with the financial depression and rising inflation has a negative effect on the development and activities of the financial sector, but with inflation rate above the threshold rate of inflation, this relationship seems to be fragile (Haslag and Koo, 1999). Some believe that inflation rates higher than 3 to 6% can have serious negative effects on the development of the financial sector (Khan et al, 2006). Among the reasons of the negative effects of inflation on financial development, I can point on the rising of interest rate due to inflation and increase of the cost of attracting foreign credits by banks.…”

Financial market performance and growth in Africa

“…For instance, by lowering real rates, high levels of inflation exacerbate the adverse selection problem on the credit market, leading to more credit rationing (to prevent lenders from misrepresenting their types and misallocating funds) and to less funds for investment and growth (Khan, Senhadji and Smith, 2006). the cost of capital and increasing its availability.…”

Does financial VAT affect the size of the financial sector?

“…Nevertheless, a problem emerges when trying to quantify the size of the financial sector, because it is difficult to find available variables for posterior analysis that reflect faithfully the idea of the depth of the financial sector. Khan et al (2006) analyzes financial size by the study of different variables called "fd" (acronym of financial depth). The variable fd1 measures the domestic credit (loans) provided to the private sector over total GDP.…”

“…Macroeconomic variables are also taken into account in the literature, for instance economic stability, measured by the inflation rate (Huybens and Smith, 1999;English, 1999;Boyd et al, 2001;Khan et al, 2006;and Bahadir and Valev, 2015), the degree of economic prosperity of a country, measured by the level of GDP per capita, or the population, (King and Levine, 1993;Levine, 1997;Jaffee and Levonian, 2001). Nonetheless, Cecchetti and Kharroubi (2012) show that financial development affects growth: it is good only up to a point, after which it becomes a drag on growth (see also Dominguez Martinez and Lopez Del Paso, 2014).…”