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Public debt and Financial development: A theoretical exploration

  • M Ismihan
  • G Ozkan

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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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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  1. Levine, Ross, 1996. "Financial development and economic growth : views and agenda," Policy Research Working Paper Series 1678, The World Bank.
  2. 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.
  3. Ismihan, Mustafa & Gulcin Ozkan, F., 2004. "Does central bank independence lower inflation?," Economics Letters, Elsevier, vol. 84(3), pages 305-309, September.
  4. Hauner, David, 2009. "Public debt and financial development," Journal of Development Economics, Elsevier, vol. 88(1), pages 171-183, January.
  5. Arvid Raknerud & Bjørn Helge Vatne & Ketil Rakkestad, 2011. "How do banks’ funding costs affect interest margins?," Working Paper 2011/09, Norges Bank.
  6. 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.
  7. F. Gulcin Ozkan & Ahmet Kipici & Mustafa Ismihan, 2008. "The Banking Sector, Government Bonds and Financial Intermediation: The Case of Emerging Market Countries," Discussion Papers 08/11, Department of Economics, University of York.
  8. Ricardo J. Caballero & Arvind Krishnamurthy, 2004. "Fiscal Policy and Financial Depth," NBER Working Papers 10532, National Bureau of Economic Research, Inc.
  9. 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.
  10. 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.
  11. M. Shahe Emran & Subika Farazi, 2009. "Lazy Banks? Government Borrowing and Private Credit in Developing Countries," Working Papers 2009-09, The George Washington University, Institute for International Economic Policy.
  12. Hauner, David, 2008. "Credit to government and banking sector performance," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1499-1507, August.
  13. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, June.
  14. 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.
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