Finance and Growth: Finance and Growth: a Micro-founded Approacha Micro-founded Approach

Federica BarziFederica BarziSeminario 21-22 dicembre 2005Seminario 21-22 dicembre 2005

Dipartimento di Scienze EconomicheDipartimento di Scienze EconomicheUniversità di VeronaUniversità di Verona

ObjectivesObjectives relationship between the development of financial relationship between the development of financial

system structure and economic growthsystem structure and economic growth measures to encourage financial developmentmeasures to encourage financial development equilibrium the financial system through the general equilibrium the financial system through the general

equilibrium model (FAGE)equilibrium model (FAGE) comparative statics analysis on a financial general comparative statics analysis on a financial general

equilibrium framework equilibrium framework impact of different financial policiesimpact of different financial policies

IssuesIssues which financial variables need to be modified in order which financial variables need to be modified in order

to ensure a sustainable financial-economic equilibrium to ensure a sustainable financial-economic equilibrium and growth?and growth?

does an optimum and correct balance between does an optimum and correct balance between freedom and control in financial flows movements freedom and control in financial flows movements exist and, if so, is it really best suited to provide exist and, if so, is it really best suited to provide economic growth?economic growth?

how can a financial authority gain control to lead the how can a financial authority gain control to lead the economy out of crises or stagnation?economy out of crises or stagnation?

How to gauge financial structure?How to gauge financial structure?

“…“…it is a holistic concept similar to the matrix of it is a holistic concept similar to the matrix of coefficients in an input-output table, the cells here coefficients in an input-output table, the cells here measuring the relationship of a given financial item measuring the relationship of a given financial item to the total of all financial instruments outstanding in to the total of all financial instruments outstanding in a country at a given date, or to the total transactions a country at a given date, or to the total transactions in financial instruments during a given period” in financial instruments during a given period” Goldsmith 1975Goldsmith 1975

AgentsAgents HouseholdsHouseholds FirmsFirms GovernmentGovernment Central bankCentral bank Rest of the worldRest of the world

+ Commercial banks+ Commercial banks+ Non-bank financial system+ Non-bank financial system+ Stock exchange markets+ Stock exchange markets(+ Financial planner)(+ Financial planner)

MethodologyMethodology Financial applied general equilibrium (FAGE)Financial applied general equilibrium (FAGE)

Stock-Flow consistent model (SFC)Stock-Flow consistent model (SFC)

Econometrics analyses (panel data)Econometrics analyses (panel data)

Implementation through dynamic modelsImplementation through dynamic models

AGEAGE Attempts to simulate numerically the general Attempts to simulate numerically the general

equilibrium structure of an economyequilibrium structure of an economy Walras law: demand equals supply for all Walras law: demand equals supply for all

commodities, at a set of relative prices that can be commodities, at a set of relative prices that can be identified (identified (Arrow-Debreu modelArrow-Debreu model))

An equilibrium does exists (An equilibrium does exists (Fixed point theorem, Fixed point theorem, Scarf’s algorithmScarf’s algorithm))

FAGEFAGE Basic data (national accounts, balance of Basic data (national accounts, balance of

payments, input-output tables, bank and financial payments, input-output tables, bank and financial systems interflows)systems interflows)

Benchmark equilibrium dataset Benchmark equilibrium dataset Choice of functional forms according to economic Choice of functional forms according to economic

and financial variables directly affected by changes and financial variables directly affected by changes in financial policy;in financial policy;

Calibration of the model;Calibration of the model; Counterfactual equilibrium for policy changeCounterfactual equilibrium for policy change

HINTS FOR MODELLINGHINTS FOR MODELLING

F-Listed Class (i)

F-Non Listed Class (j)

H-Investors Class (h)

H-Non Investors Class (k)

iAz

izzi

iiNDi AUdiv)FwXsPd(

i

Pr)FwXsPd(z

jzzj

jjNDj

hB

hD

hiAlablabh BrDrAUdivFwY

i

lablabk FwY

HINTS FOR MODELLING

F-Listed Class (i)

F-Non Listed Class (j)

H-Investors Class (h)

H-Non Investors Class (k)

SOURCES

1

jPB

FCOST

jFj KjjK

jPBaFP

patrpatrpatrpatr

i

1h

3h

2ihi1h BDAPT

patrpatrpatr1

k3

k2k BDPT

SOURCES

1

iPBiA

FCOST

iF iKiK

iiK

iiPBaAaFP

FAGEFAGEStrengthsStrengths WeaknessesWeaknesses

Solid Microfoundations Limited range of f. forms and stylized sectors of the economy

Estimation of Welfare Effects Sensitivity to closure rules

Distributional aspects Inability to assess the outcomes

Connection between aggregate variables and disaggregated sub-structure

Inter-temporal substitution and dynamics, expectations

Facilities for simulations of alternatives and flexibility

Large scale models closed to reality are impossible to solve

Applicability to complex problems Demanding data requirements

SFCSFC It implies the setting of a matrix (FAM - financial It implies the setting of a matrix (FAM - financial

accounting matrix) similar to a SAMaccounting matrix) similar to a SAM

This provides “This provides “a systematic listing of the financial a systematic listing of the financial stocks” where the assets of the agents are stocks” where the assets of the agents are displayed by rows and liabilities by columnsdisplayed by rows and liabilities by columns

SFCSFC Main differences between SAM and FAMMain differences between SAM and FAM SAM FAMDouble-entry table build on the base of an input- output table

The denomination of columns differ from that of rows

Monetary (nominal) flows Financial flowsTotal sum of rows have to equate the total sum of columns

No balancing requirements

EconometricsEconometrics i.e. : King-Levine (1993a) - i.e. : King-Levine (1993a) - Levine Zervos (1998) Cross-country regression modelCross-country regression model

G(j)= a + b F(i) + c X + uG(j)= a + b F(i) + c X + uG(j) = growth indicatorsG(j) = growth indicatorsF(i) = financial development indicators (FinDI)F(i) = financial development indicators (FinDI) X = other regressorsX = other regressors

Growth indicators Growth indicators King-Levine (1993a)King-Levine (1993a)

Long-run per capita growth ratesLong-run per capita growth rates

Capital accumulationCapital accumulation

Productivity growthProductivity growth

FinDIFinDI King-Levine (1993a)King-Levine (1993a)

DEPTH(+) DEPTH(+)

BANK (+)BANK (+)

PRIVY(+)PRIVY(+)

GDPSLIABILITIELIQUIDDEPTH

ASSETSDOMESTICBANKCENTRALCREDITBANKCREDITBANKOFRATIOBANK

GDPENTERPRISEPRIVATETOCREDITPRIVY

.INTERM.FINBANKNONOF.LIABBANKSOF.LIABCURRENCYSLIABILITIELIQUID

FinDILevine Zervos (1998)

Turnover ratio (+)

Stock market size( ̴)

TIONCAPITALIZAMARKETSTOCKSECOUNTRYAONTRADEDSHAREOFVALUETOTAL

GDPTIONCAPITALIZAMARKET

Role of institutions Role of institutions

Gov Rest of the World

-Income/corporate taxes-Export subsidies-Import tariffs-Value added taxes-Transfers to households andenterprises-Real government consumption-Real government investment-Infrastructure projects

-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 institutionsRole of financial institutions

Banking system Non-bank fin. system Stock Exchange

Central Bank:-Minimum foreign exchange reserves -Central Bank interest rate-Nominal exchange rateCommercial banks:-Access to credits-Flexibility of credit allocation

-Running of non-bank projects

-Fees for funds

management

-Capital adequacy requirements-Cost of listing-Takeover constraints

Stock market and growthStock market and growth Theoretical debate:Theoretical debate:

Does stock market support economic growth, Does stock market support economic growth, capital accumulation, productivity innovation?capital accumulation, productivity innovation?

How stock market and banks compete in funding How stock market and banks compete in funding firms’ growth?firms’ growth?

Possible complementaritiesPossible complementarities

Intuition

Simply listing on the national stock exchange does Simply listing on the national stock exchange does not necessarily foster resource allocationnot necessarily foster resource allocation

It must be implemented with the trading of It must be implemented with the trading of productive technologiesproductive technologies

Plus human capital investmentPlus human capital investment