Financial Innovation, Economic Growth, and the Consequences of Macroprudential Policies

Abstract

We leverage a ‘catch-all’ measure of financial innovation – research and development spending in the financial sector – to assess the net relationship between financial innovation and economic growth and evaluate the influence of macroprudential policy on this relationship. Using a panel of 23 countries over the period of 1996-2014, our results demonstrate a net-positive relationship between financial innovation and gross capital formation. We find no evidence of a net-negative impact of financial innovation on economic growth, challenging the popular and political stigma surrounding financial innovation. We also find little robust evidence of macroprudential policy influencing the relationship between financial innovation and economic growth. Our results support a functional approach to the regulation of financial innovation, which improves the intermediation process, leading to increased capital formation.

Keywords: Financial innovation, Macroprudential policy, Economic growth, Capital formation, Financial intermediation

JEL Classification: E44, G01, G20, G28