Financial Development, Financial Fragility, and Growth

UPF Working Paper 855

35 Pages Posted: 30 Nov 2005

See all articles by Norman Loayza

Norman Loayza

World Bank - Research Department

Romain G. Rancière

University of Southern California

Multiple version iconThere are 3 versions of this paper

Date Written: September 2004

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.,Levine, Loayza, and Beck 2000). 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.

Keywords: Financial development

JEL Classification: 016, G21, C33

Suggested Citation

Loayza, Norman and Rancière, Romain G., Financial Development, Financial Fragility, and Growth (September 2004). Available at SSRN: https://ssrn.com/abstract=859565 or http://dx.doi.org/10.2139/ssrn.859565

Norman Loayza

World Bank - Research Department ( email )

1818 H Street, N.W.
Washington, DC 20433
United States

Romain G. Rancière (Contact Author)

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
263
Abstract Views
1,543
rank
17,173
PlumX Metrics