What Is Happening to the Impact of Financial Deepening on Economic Growth?

Abstract

Although the finance-growth relationship is now firmly entrenched in the empirical literature, we show that it is not as strong in more recent data as it was in the original studies with data for the period from 1960 to 1989. We consider two related explanations. First, excessive financial deepening or too rapid growth of credit may have led to both inflation and weakened banking systems which in turn gave rise to growthinhibiting financial crises. Second, excessive financial deepening may be a result of widespread financial liberalizations in the late 1980s and early 1990s in countries that lacked the legal or regulatory infrastructure to exploit financial development successfully.We find that the increased incidence of financial crises since the 1990s is primarily responsible for the recent weakening of the finance-growth link, but find no direct evidence that liberalizations played an important supporting role.

Is the Relationship Between Financial Development and Economic Growth Monotonic? Evidence from a Sample of Middle-Income Countries

“…Finally, addressing similar questions as Loayza and Ranciere (2006), but using a somewhat different approach, Rousseau and Wachtel (2011) show that the impact of financial deepening on growth is not as strong with more recent panel data (1990)(1991)(1992)(1993)(1994)(1995)(1996)(1997)(1998)(1999)(2000)(2001)(2002)(2003)(2004) as for the period from 1960 to 1989. They posit that the rapid growth of credit and widespread liberalization in the nineties led to both inflationary pressures and a weakening of the banking system that ultimately triggered financial crises, which are responsible for "the disappearance of the finance effect".…”

“…The dynamic panel threshold estimation results of equation (6) Rousseau and Wachtel, 2011;Law and Singh, 2014, among others). As for control variables, almost all variables used in the threshold model have coefficients similar to those we obtained in our previous finding with the exception of fixed capital formation and population.…”

“…In doing so, we explore the nature of the relationship between financial development and economic growth, and especially consider whether it may in fact be non-monotonic. Indeed, much of the current literature suggests that the impact of financial deepening on growth becomes negative once a certain threshold is reached (Arcand et al, 2012;Cecchetti and Kharroubi, 2012), or that this impact seems to have evaporated in recent data (Rousseau and Wachtel, 2011).…”

A Comparative Empirical Analysis of Financial Development Indicators Between Transition Economies and Developed Ones

“…For example, it was found that this relationship is positive only when inflation is below 5% [Rousseau, Wachtel 2002]. It was also proven that their relationship is weaker in developing countries and might has weakened further over the years [Rousseau,Wachtel 2011].…”

Finance and Balanced Growth

“…1 A number of other results have suggested that the empirical evidence is not consistently positive, however. Important variations have been shown to exist in the significance and direction of finance-growth connection across countries (Demetriades and Hussein, 1996), across stages of development (Rioja and Valev, 2004), and across time (Rousseau and Wachtel, 2010).…”