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Financial Development And Economic Growth

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  • Khan, Aubhik

Abstract

We develop a theory of financial development based on the costs associated with the provision of external finance. These costs arise through informational asymmetries between borrowers and lenders that are costly to resolve. When borrowing is limited, producers with access to financial intermediary loans obtain higher returns to investment than other producers. This creates incentives for others to undertake the technology adoption necessary to access investment loans. Over time, as increasing numbers of producers gain access to external finance, borrowers net worth rises relative to debt. This reduces the costs of financial intermediation and raises the overall return on investment. The theory is consistent with recent evidence that financial development reduces the costs associated with the provision of external finance and increases the rate of economic growth. Furthermore, the theory predicts that financial development will raise the return on loans and reduce the spread between borrowing and lending rates.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 5 (2001)
Issue (Month): 03 (June)
Pages: 413-433

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Handle: RePEc:cup:macdyn:v:5:y:2001:i:03:p:413-433_02

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  17. Mark Gertler & Simon Gilchrist, 1993. "Monetary policy, business cycles and the behavior of small manufacturing firms," Finance and Economics Discussion Series 93-4, Board of Governors of the Federal Reserve System (U.S.).
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