Financial development and economic growth: long‐run equilibrium and transitional dynamics

Abstract

We analyze the impact of financial development on economic growth. Differently from previous studies that focus mainly on balanced growth path outcomes, we also analyze the transitional dynamics of our model economy by using a finance‐extended Uzawa–Lucas framework where financial intermediation affects both human and physical capital accumulation. We show that, under certain rather general conditions, economic growth may turn out to be non‐monotonically related to financial development (as suggested by the most recent empirical evidence) and that too much finance may be detrimental to growth. We also show that the degree of financial development may affect the speed of convergence, which suggests that finance may play a crucial role in determining the length of the recovery process associated with exogenous shocks. Moreover, in a special case of the model, we observe that, under a realistic set of parameters, social welfare decreases with financial development, meaning that even when finance positively affects economic growth the short‐term costs associated with financial activities more than compensate their long‐run benefits.

Introduction to the Macroeconomic Dynamics Special Issue On: Growth in the Aftermath of the Financial Crisis: Theories, Policies, and Sources of Sustainable Development

“…NOTE 1. Bucci and Marsiglio (2019), in particular, find conditions under which human capital-based economic growth and financial development turn out to be non-monotonically related. Specifically, since in their framework financial development affects simultaneously the productivity of skill acquisition and the obsolescence rate of human capital, their analysis suggests that the human-capital-channel may represent an important starting point to shed some light on why in some countries there may be too much finance while in others too little.…”

“…In this regard, starting from the seminal papers by Galor and Zeira (1993) and Banerjee and Newman (1993), it is now clear that the presence of possible borrowing constraints may contribute, among others, to slow down the accumulation of human capital, which, in turn, has an impact on the distribution of income and the rate of long-term economic growth. It is therefore plausible [Jerzmanowski (2017) and Bucci and Marsiglio (2019)] that financial development may indirectly affect economic growth and income inequality via the human capital channel. 1 Recent evidence, indeed, already points to the fact that the demand for higher education increased in financially deregulated states as private student loans from banks became cheaper and more readily available [Sun and Yannelis (2016)].…”

The closed-form solutions for finance-extended Lucas–Uzawa model

“…extended the basic Lucas-Uzawa model (Lucas 1988;Uzawa 1965) to study the role of financial development in determination of economic growth of the Bucci et al (2018) extended the one-sector Ramsey model (Ramsey 1928) to study the role of financial development in the determination of economic growth of the economy. Bucci and Marsiglio (2018) and Bucci et al (2018) are significant contributions in theoretical literature on economic growth theory and have led a foundation of modeling of exogenous factors in theoretical models. Boucekkine and Ruiz-Tamarit (2008) established the closed-form solutions of the Lucas-Uzawa model under no parameter restrictions and expressed the closed-form solutions in terms of hypergeometric functions.…”

“…In this paper, I establish the closed-form solutions for all the variables in the financeextended Lucas-Uzawa model under no parameter restrictions by utilizing the partial Hamiltonian approach (Naz et al 2014;Naz 2016;Naz and Naeem 2018) and second by direct utilization of the standard methods. I started with an overview of the model and the properties of BGP as discussed in Bucci and Marsiglio (2018). I have provided sufficient conditions as well.…”

“…The growth rates of all the variables in the model are established. The properties of BGP as described by Bucci and Marsiglio (2018) are analyzed and some additional properties are provided as well. Second, I establish the closed-form solution for all the variables of the model by utilizing the standard methods which can be, alternatively, derived by utilizing one first integral.…”