Peter L. Rousseau

Financial Intermediation and Economic Performance: Historical Evidence from Five Industrialized Countries

This paper examines the nature of links between the intensity of financial intermediation and economic performance that operated in the United States, the United Kingdom, Canada, Norway, and Sweden over the 1870-1929 period. After describing the coevolution of the financial and real sectors in these countries, vector error correction models (VECMs) establish the quantitative importance of long-run relationships among measures of financial intensity and real per capita levels of output and the monetary base. Granger causality tests then suggest a leading role for the intermediation variables in real sector activity, while feedback effects are largely insignificant. The results suggest an important role for intermediation in the rapid industrial transformations of all five counries.

Equity markets and growth: Cross-country evidence on timing and outcomes, 1980-1995

Abstract The rapid expansion of organized equity exchanges in both emerging and developed markets has prompted policymakers to raise important questions about their macroeconomic impact, yet the need to focus on recent data poses implementation difficulties for econometric studies of dynamic interactions between stock markets and economic performance in individual countries. This paper overcomes some of these difficulties by applying recent developments in the analysis of panels with a small time dimension to estimate vector autoregressions for a set of 47 countries with annual data for 1980–1995. After describing recent theories on the role of stock markets in growth and considering a pure cross-sectional empirical approach, our panel VARs show leading roles for stock market liquidity and the intensity of activity in traditional financial intermediaries on per capita output. The findings underscore the potential gains associated with developing deep and liquid financial markets in an increasingly global economy.

Inflation Thresholds and the Finance-Growth Nexus

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What is happening to the impact of financial deepening on economic growth

Although the finance-growth relationship is now firmly entrenched in the empirical literature, we show that it is not as strong in more recent data as it was in the original studies with data for the period from 1960 to 1989. We consider several explanations. First, we find that the incidence of financial crises is related to the dampening of the effect of financial deepening on growth. Excessive financial deepening or too rapid growth of credit may have led to both inflation and weakened banking systems which in turn gave rise to growth-inhibiting financial crises. Excessive financial deepening may also be a result of widespread financial liberalizations in the late 1980s and early 1990s in countries that lacked the legal or regulatory infrastructure to exploit financial development successfully. However, we find little indication that liberalizations played an important direct in reducing the effect of finance. Similarly, there is little evidence that the growth of equity markets in recent years has substituted for debt financing and led to a reduced role of financial deepening on growth.

Post-Independence India: A Case of Finance-Led Industrialization?

This paper examines whether financial intermediaries have played a leading role in influencing Indias economic performance. After describing the evolution and functions of the financial sector, we construct a set of vector autoregressive and vector error correction models to evaluate the strength and direction of the links between measures of formal intermediation and various economic aggregates. The results suggest that (i) the financial sector was instrumental not only in promoting aggregate investment and output, but also in the steady shift toward industry that has characterized Indias development; (ii) the operative channel was one of debt accumulation rather than improvements in total factor productivity; and (iii) its contributions went beyond the passive support of fiscal policy.

Economic Growth and Financial Depth: Is the Relationship Extinct Already?

Although the finance–growth nexus has become firmly entrenched in the empirical literature, studies that question the strength of the empirical results have appeared and seem to have become more frequent as well. A re-examination of the core cross- country panel results that established the relationship between financial depth and growth rates are done. The sensitivity of the core result to changes in time period and variation in the sample of countries included are also examined.

Inflation, Financial Development and Growth

The last decade saw an explosion in research interest on economic growth. In particular, there have been a large number of thorough empirical investigations of the differences in growth rates among countries over long periods of time. These studies tend to emphasize particular aspects or causes of the growth process. Among the important correlates of economic growth that have been studied are inflation and the extent of financial sector development. In this paper we examine the interaction between the growth-inflation and growth-finance relationships.

Finance, investment, and growth in Meiji-era Japan

Abstract This paper examines whether financial factors played a leading role in the rising investment rates and per capita incomes that characterized Japan over the 1880–1913 period. After an account of financial reforms undertaken during the Meiji transition (1868–1884) that created favorable conditions for successful finance-led development, a set of vector autoregressive models offers evidence that the financial sector was indeed instrumental in promoting Japans rise to world prominence by the eve of the First World War.

The permanent effects of innovation on financial depth:: Theory and US historical evidence from unobservable components models

This paper focuses on innovation as a determinant of the rapid financial deepening that characterized the U.S. economy from 1872 to 1929. After describing the key innovations adopted by national banks in New York City over this period, it presents an example in which better loan monitoring in the presence of adverse selection and a risk-return tradeoff can allow a nearly-competitive intermediary to earn temporary rents by lowering the interest rate on loans. Subsequent use of the improved technology by other lenders and Bertrand competition for loanable funds then raises the deposit rate and encourages flows to the intermediating sector. The implication that permanent reductions in the loan-deposit spread offered by New York City national banks led to increases in financial depth is then examined with a state-space model in which transitory and permanent components are extracted from measures of the loan-deposit spread and financial depth. The permanent components are modeled as independent random walks, with innovations in the permanent component of the spread exerting an influence on financial depth that cannot be attributed to its own permanent component. The maximum likelihood estimates, generated via the Kalman filter, indicate that one percentage point reductions in the spread are related to statistically significant increases of as much as 3.8% in the ratios of intermediary assets to GNP and reductions of as much as 6.4% in the ratios of bank capital to assets. The paper also presents evidence that available proxies for financial innovation are strongly related to spread fluctuations.

Inflation, Financial Development and Growth: A Trilateral Analysis

A large body of evidence links financial development to economic growth, yet the channels through which inflation affects this relationship and its stability have been less thoroughly explored. We take an econometric and graphical approach to examining these channels, and find that higher levels of financial development, combined with low-inflation, are related to higher rates of economic growth, especially in lower income countries, but that financial development loses much of its explanatory power in the presence of high-inflation. In particular, small increases in the price level seem able to wipe out relatively large growth effects of financial deepening when the annual rate of inflation lies between 4% and 19%, whereas the operation of the finance-growth link is less affected by inflation rates above this range. Growth is generally much lower, however, in such high-inflation settings where financial development is typically repressed.