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Wealth, financial intermediation and growth

  • Alejandro Gaytan
  • Romain Rancière

This paper presents empirical support for the existence of wealth effects in the contribution of financial intermediation to economic growth, and offers a theoretical explanation for these effects. Using GMM dynamic panel data techniques applied to study the growth-promoting effects of financial intermediation, we show that the exogenous contribution of financial development on economic growth has different effects for different levels of income per capita. We find that this contribution is generally increasing with the level of income per capita of the economy, up to a relatively high level of income. This contribution is consistently lower for poor countries; and for some low levels of income per capita it can be negative. We provide a model to account for these wealth effects. The model is a overlapping generations growth model where financial intermediaries implement liquidity risk sharing among depositors. We show that at early stages of economic development, a bank can increase welfare of its depositors only at the cost of lowering investment and growth. However, once the economy has crossed certain wealth threshold, the liquidity role of banks becomes unambiguously growth enhancing. As wealth increases, banks offer improving liquidity insurance, and higher growth; however, for high levels of wealth, growth generated by financial intermediation declines as the economy attains the optimal level of consumption risk sharing.

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File URL: http://www.econ.upf.edu/docs/papers/downloads/851.pdf
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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 851.

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Date of creation: Jan 2004
Date of revision: Apr 2004
Handle: RePEc:upf:upfgen:851
Contact details of provider: Web page: http://www.econ.upf.edu/

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