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Public debt and Financial development: A theoretical exploration

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  • M Ismihan
  • G Ozkan

Abstract

This paper proposes an analytical framework to examine the role of public debt in financial development, which remains largely unexplored in the existing literature. We find that in countries where the banking sector extends substantial credit to government, public debt is likely to harm financial development, with unfavourable implications for economic activity. As such, our results provide an alternative explanation for the ‘contractionary fiscal expansions’. We also show that the lower the financial depth, the greater the adverse effects of public borrowing on financial development and macroeconomic outcomes.

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Bibliographic Info

Paper provided by Department of Economics, University of York in its series Discussion Papers with number 10/14.

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Date of creation: Jun 2010
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Handle: RePEc:yor:yorken:10/14

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Keywords: Financial sector; credit to government; public debt.;

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  1. Beetsma, Roel M. W. J. & Bovenberg, A. Lans, 1999. "Does monetary unification lead to excessive debt accumulation?," Journal of Public Economics, Elsevier, vol. 74(3), pages 299-325, December.
  2. Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 75-122 National Bureau of Economic Research, Inc.
  3. King, Robert G. & Levine, Ross, 1993. "Finance, entrepreneurship and growth: Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 32(3), pages 513-542, December.
  4. F. Gulcin Ozkan & Ahmet Kipici & Mustafa Ismihan, 2010. "The Banking Sector, Government Bonds, and Financial Intermediation: The Case of Emerging Market Countries," Emerging Markets Finance and Trade, M.E. Sharpe, Inc., vol. 46(4), pages 55-70, January.
  5. Levine, Ross, 1996. "Financial development and economic growth : views and agenda," Policy Research Working Paper Series 1678, The World Bank.
  6. Hauner, David, 2009. "Public debt and financial development," Journal of Development Economics, Elsevier, vol. 88(1), pages 171-183, January.
  7. Ricardo J. Caballero & Arvind Krishnamurthy, 2004. "Fiscal Policy and Financial Depth," NBER Working Papers 10532, National Bureau of Economic Research, Inc.
  8. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
  9. Coccorese, Paolo, 2005. "Competition in markets with dominant firms: A note on the evidence from the Italian banking industry," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1083-1093, May.
  10. Arvid Raknerud & Bjørn Helge Vatne & Ketil Rakkestad, 2011. "How do banks’ funding costs affect interest margins?," Working Paper 2011/09, Norges Bank.
  11. von Hagen, Jurgen & Strauch, Rolf R, 2001. " Fiscal Consolidations: Quality, Economic Conditions, and Success," Public Choice, Springer, vol. 109(3-4), pages 327-46, December.
  12. Ismihan, Mustafa & Gulcin Ozkan, F., 2004. "Does central bank independence lower inflation?," Economics Letters, Elsevier, vol. 84(3), pages 305-309, September.
  13. Hauner, David, 2008. "Credit to government and banking sector performance," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1499-1507, August.
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