Wealth, Financial Intermediation and Growth

UPF Economics and Business Working Paper 851

47 Pages Posted: 30 Nov 2005

See all articles by Alejandro Gaytan

Alejandro Gaytan

Banco de Mexico, Macrofinancial Analysis Division

Romain G. Rancière

University of Southern California

Date Written: January 2004

Abstract

This paper presents empirical support for the existence of wealth effects in the contribution of financial intermediation to economic growth, and offers a theoretical explanation for these effects. Using GMM dynamic panel data techniques applied to study the growth-promoting effects of financial intermediation, we show that the exogenous contribution of financial development on economic growth has different effects for different levels of income per capita. We find that this contribution is generally increasing with the level of income per capita of the economy, up to a relatively high level of income. This contribution is consistently lower for poor countries; and for some low levels of income per capita it can be negative. We provide a model to account for these wealth effects. The model is a overlapping generations growth model where financial intermediaries implement liquidity risk sharing among depositors. We show that at early stages of economic development, a bank can increase welfare of its depositors only at the cost of lowering investment and growth. However, once the economy has crossed certain wealth threshold, the liquidity role of banks becomes unambiguously growth enhancing. As wealth increases, banks offer improving liquidity insurance, and higher growth; however, for high levels of wealth, growth generated by financial intermediation declines as the economy attains the optimal level of consumption risk sharing.

Keywords: Financial development, economic growth, OLG growth models, liquidity, financial intermediation

JEL Classification: E44, G21, O16, O40

Suggested Citation

Gaytan, Alejandro and Rancière, Romain G., Wealth, Financial Intermediation and Growth (January 2004). Available at SSRN: https://ssrn.com/abstract=860925 or http://dx.doi.org/10.2139/ssrn.860925

Alejandro Gaytan (Contact Author)

Banco de Mexico, Macrofinancial Analysis Division ( email )

5 de mayo 18, 5th floor,
Col. Centro
Mexico City, 06059 D.F. 06059
Mexico
(5255) 5237 2611 (Phone)
(5255) 5237 2687 (Fax)

Romain G. Rancière

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

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