Working Paper

Financial structure and macroeconomic performance over the short and long run

Abstract: We examine the relationship between indicators of financial development and economic performance for a cross-country panel over long and short periods. Our long-term results are consistent with much of the literature in that we find a positive relationship between financial development and economic growth. However, we fail to find a significant positive relationship after accounting for disparities in factor accumulation. These results therefore indicate that the primary channel for financial development to facilitate growth over the long run is through physical and human capital accumulation. We also identify a significant negative relationship between financial development and income volatility, suggesting that financial development does mitigate economic fluctuations in the long run. ; We then turn to short-run analysis, concentrating on the period immediately surrounding the 1997 Asian financial crisis. Unlike our long-term results, our short-term panel analysis fails to find a significant relationship financial development and economic performance during this period, both for a broad sample of countries and for a small sample of developing Asian nations. ; Taken as a whole, our analysis appears to support a relatively new idea in the literature that while financial development is beneficial over the long run, it may exacerbate short-term volatility in isolated episodes. One reason for this discrepancy may be that financial liberalizations are typically only partial, resulting in increased financial market distortions. We analyze the Korean experience in the period surrounding the Asian financial crisis and argue that this experience supports the idea of distortionary partial liberalization.

Keywords: Banking structure; Financial institutions;

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Pacific Basin Working Paper Series

Publication Date: 2002

Number: 2002-05