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ON THE (NONMONOTONIC) RELATION BETWEEN ECONOMIC GROWTH AND FINANCE

Published online by Cambridge University Press:  06 June 2018

Alberto Bucci,
Simone Marsiglio and
Catherine Prettner
Alberto Bucci
Affiliation:
University of Milan
Simone Marsiglio*
Affiliation:
University of Wollongong
Catherine Prettner
Affiliation:
Statistics Austria and Vienna University of Economics and Business
*
Address correspondence to: Simone Marsiglio, School of Accounting, Economics and Finance, University of Wollongong, Northfields Avenue, Wollongong 2522 NSW, Australia; e-mail: simonem@uow.edu.au.
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Abstract

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We analyze the simplest possible model of endogenous growth to account for the role of financial development. In our setting, financial development affects productivity and determines the amount of resources subtracted to capital investment. We show that under very general assumptions, the relation between economic growth and financial depth is nonmonotonic, and eventually bell-shaped. We empirically assess our results in a framework that allows to distinguish between long-run and short-run effects. We establish a cointegrating relation and derive the long-run elasticities of per capita gross domestic product (GDP) with respect to employment, the physical capital stock, and financial depth–relying on linear as well as nonlinear models for the finance-growth nexus. We employ the results of the first step estimation to specify an error–correction model and find that there is strong evidence for a nonlinear relationship between financial depth and per capita GDP, consistently with what was predicted by our theoretical model.

Keywords

Economic GrowthFinancial DepthFinancial Development

Footnotes

We are indebted to an anonymous referee for valuable comments and suggestions. We also wish to thank the participants in the conference “Economics, Economic Policies and Sustainable Growth in the Wake of the Crisis” [Ancona (2016)] for insightful discussions. All remaining errors and omissions are our own sole responsibility.

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