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Finance and Growth: a Micro-founded Approach Federica Barzi Seminario 21-22 dicembre 2005 Dipartimento di Scienze Economiche Università di Verona Objectives relationship between the development of financial system structure and economic growth measures to encourage financial development equilibrium the financial system through the general equilibrium model (FAGE) comparative statics analysis on a financial general equilibrium framework impact of different financial policies Issues which financial variables need to be modified in order to ensure a sustainable financial-economic equilibrium and growth? does an optimum and correct balance between freedom and control in financial flows movements exist and, if so, is it really best suited to provide economic growth? how can a financial authority gain control to lead the economy out of crises or stagnation? How to gauge financial structure? “…it is a holistic concept similar to the matrix of coefficients in an input-output table, the cells here measuring the relationship of a given financial item to the total of all financial instruments outstanding in a country at a given date, or to the total transactions in financial instruments during a given period” Goldsmith 1975 Agents Households Firms Government Central bank Rest of the world + Commercial banks + Non-bank financial system + Stock exchange markets (+ Financial planner) Methodology Financial applied general equilibrium (FAGE) Stock-Flow consistent model (SFC) Econometrics analyses (panel data) Implementation through dynamic models AGE Attempts to simulate numerically the general equilibrium structure of an economy Walras law: demand equals supply for all commodities, at a set of relative prices that can be identified (Arrow-Debreu model) An equilibrium does exists (Fixed point theorem, Scarf’s algorithm) FAGE Basic data (national accounts, balance of payments, input-output tables, bank and financial systems interflows) Benchmark equilibrium dataset Choice of functional forms according to economic and financial variables directly affected by changes in financial policy; Calibration of the model; Counterfactual equilibrium for policy change HINTS FOR MODELLING F-Listed Class (i) F-Non Listed Class (j) iND ( Pd i Xs i w z Fiz ) Udiv Ai Ai i z ND ( Pd j Xs j w z Fjz ) Pr j j z H-Investors Class (h) Yh w lab Flab Udiv Ai A ih rD D h rB Bh H-Non Investors Class (k) Yk w lab Flab HINTS FOR MODELLING F-Listed Class (i) P F a A a PB F-Non Listed Class (j) P F a PB H-Investors Class (h) H-Non Investors Class (k) K i Fi i Ai i PBi FCOST Fj i 1 K i SOURCES j PBj FCOST PTh K i j 1 K j Kj SOURCES A D i 1i PTk 2 D h patr i k patr h patr 2 3 B h patr 3 B k patr 1 patr 1 patr FAGE Strengths Solid Microfoundations Weaknesses Estimation of Welfare Effects Limited range of f. forms and stylized sectors of the economy Sensitivity to closure rules Distributional aspects Inability to assess the outcomes Connection between aggregate variables and disaggregated substructure Facilities for simulations of alternatives and flexibility Applicability to complex problems Inter-temporal substitution and dynamics, expectations Large scale models closed to reality are impossible to solve Demanding data requirements SFC It implies the setting of a matrix (FAM - financial accounting matrix) similar to a SAM This provides “a systematic listing of the financial stocks” where the assets of the agents are displayed by rows and liabilities by columns SFC Main differences between SAM and FAM SAM Double-entry table build on the base of an input- output table Monetary (nominal) flows Total sum of rows have to equate the total sum of columns FAM The denomination of columns differ from that of rows Financial flows No balancing requirements Econometrics i.e. : King-Levine (1993a) - Levine Zervos (1998) Cross-country regression model G(j)= a + b F(i) + c X + u G(j) = growth indicators F(i) = financial development indicators (FinDI) X = other regressors Growth indicators King-Levine (1993a) Long-run Capital per capita growth rates accumulation Productivity growth FinDI King-Levine (1993a) DEPTH(+) LIQUID LIABILITIE S DEPTH GDP LIQUID LIABILITIE S CURRENCY LIAB. OF BANKS LIAB. OF NON BANK FIN.INTERM . BANK (+) BANK RATIO OF BANK CREDIT BANK CREDIT CENTRAL BANK DOMESTIC ASSETS PRIVY(+) PRIVY CREDIT TO PRIVATE GDP ENTERPRISE FinDI Levine Zervos (1998) Turnover ratio (+) TOTAL VALUE OF SHARE TRADED ON A COUNTRY SE STOCK MARKET CAPITALIZA TION Stock market size(̴) MARKET CAPITALIZA TION GDP Role of institutions Gov -Income/corporate taxes -Export subsidies -Import tariffs -Value added taxes -Transfers to households and enterprises -Real government consumption -Real government investment -Infrastructure projects Rest of the World -Development aid -Foreign portfolio investment -Foreign direct investment -Net credit to government -Debt relief (HIPC) -Foreign interest rate (LIBOR) -Factor income from abroad -Remittances -World prices for exports -World prices for imports -Grant element of concessional credits Role of financial institutions Banking system Central Bank: -Minimum foreign exchange reserves -Central Bank interest rate -Nominal exchange rate Commercial banks: -Access to credits -Flexibility of credit allocation Non-bank fin. system -Running of non-bank projects -Fees for funds management Stock Exchange -Capital adequacy requirements -Cost of listing -Takeover constraints Stock market and growth Theoretical debate: Does stock market support economic growth, capital accumulation, productivity innovation? How stock market and banks compete in funding firms’ growth? Possible complementarities Intuition Simply listing on the national stock exchange does not necessarily foster resource allocation It must be implemented with the trading of productive technologies Plus human capital investment