Interaction between economic and financial development
This paper presents a possible explanation of the interactive nature of the relationship between economic and financial development based on absorption of resources by the financial sector, and constant returns to physical capital accumulation in the production sector. Financial intermediaries operating in a credit market characterised by monopolistic competition emerge along with the process of economic development. This could initially have a detrimental effect on growth, so that the economy might be trapped in a low development region. If not, subsequent economic develop-ment stimulates competition among financial intermediaries which results in more e¢cient …nancial transactions, and therefore higher growth. While higher e¢ciency is always associated with higher growth, the laissez faire economy can still be characterised by sub-optimal levels of financial development.
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