Finance and Growth: the Long-run and Short-run Puzzle Effect

By

Binam Raj Ghimire

Economic Growth:

Importance

Evolution of economy

Catching up with Growth

Source: http://borgenproject.org/Pictures.html

Motivation

“developments in finance enabled the industrial revolution”

- Walter Bagehot (1873)

“where enterprise leads finance follows”-Joan Robinson (1952)

“although conclusions must be stated hesitantly and with ample qualifications, ………….. suggests a positive first-order relationship between financial development and economic growth.”

- Ross Levine (1997, 2005)

Source: picture top: http://www.spartacus.schoolnet.co.uk, picture bottom: Brown University, Providence

Walter Bagehot

Ross Levine

In Literature

No Silver Bullets but …5 common ingredients

Openness to Trade

Macroeconomic stability

High rates of saving and investment

Allowed market allocation of resources

Committed, honest & capable governments

A recent report: 13 Countries, 7% pa growth, 25 Yrs.

Source: Commission on Growth and Development

Variables for Financial Development (Banks)

HSBC Bank Mexico, Source: www.newcityskyline.com

Bank Development

- Private Credit / GDP

Beck, Kunt and Levine (2007) – Bangladesh 23 % Thailand 65%

Headcount: 1983 – 26% 2000 – 36% (Could have been 15% – population living on less than one dollar a day)

Variables for Financial Development (Stock Market)

NASDAQ at Times Square, Source: www.nasdaq.com

Stock Market Development

- Capitalisation

- Traded value

- Turnover

Control Variables

Data & Methodology

titititititi XMCYY ,,3,2,11-,, -

Panel Data, Pooled, Fixed and Random Effect, OLS

25 Yrs. 208 Countries

Where

Y = Real per capita GDP

C = Private Credit

M = Stock Market

X = Control Variables

Short run and long run dynamics in economics

Short-run

Long-run

Economy is unstable

Economy is in equilibrium

Real GDP per capita growth rate

World, East Asia & Pacific1997

Results

Regressors 1 2 3 1 2 3Constant -0.021 -0.017 -0.016 0.034 0.036 0.042

(0) (0.0484) (0) (0.137) (0.0484) (0.0261)Financial Depth - Private credit 0.016 0.025 0.022 -0.039 -0.055 -0.056(domestic credit to private sector - % of GDP) (0) (0) (0) (0.0186) (0.0001) (0.0001)Turnover 0.012 0.009(stocks traded, turnover ratio) (0) (0.1783)Capitalisation -0.004 0.033(market capitalization of listed companies - % of GDP) (0.0188) (0.0001)Value traded 0.000 0.023(stocks traded, total value - % of GDP) (0.8617) (0.0041)Government consumption -0.049 -0.053 -0.057 -0.349 -0.422 -0.407(government final consumption expenditure -% of GDP) (0) (0) (0) (0) (0) (0)Capital formation 0.216 0.220 0.214 0.336 0.326 0.319(gross capital formation - % of GDP) (0) (0) (0) (0) (0) (0)Inflation -0.016 -0.020 -0.017 -0.021 -0.026 -0.027(inflation, consumer prices - annual %) (0) (0) (0) (0) (0) (0)Trade openness 0.001 -0.007 -0.006 -0.002 0.004 0.004(trade - % of GDP) (0.627) (0) (0.0001) (0.9493) (0.8236) (0.8453)Education -0.114 -0.097 -0.096 -0.128 -0.032 -0.021(secondary school enrollment - %) (0) (0) (0) (0.2485) (0.7096) (0.8129)Adjusted R-squared 0.451 0.428 0.400 0.405 0.455 0.445

Long- Run Short- RunVariables

Growth Effect with Financial Depth and Stock Market

Conclusion

Rethinking – Is there a link between financial development and economic growth?

Source: Logo – bbc.co.uk