Title: Nonlinearities in financial development
Authors: Peter Pedroni - Williams College (United States) [presenting]
Diala Al Masri - Oxford (United Kingdom)
Abstract: New data and a fundamentally new and robust panel time series approach is employed to reexamine the nonlinear relationship between financial development and long run levels of per capita income and the implied relationship between financial innovation and economic growth. In support of our approach, we use a Schumpetarian growth model to motivate our thinking about the complex nature of the nonlinear relationships inherent in the process of financial development. The new empirical approach reveals that, consistent with such a modeling framework, financial development typically encompasses both convex and concave relationships between rates of financial innovation and economics growth, which can be accentuated or diminished depending on the mix of financial attributes and the presence of various economic conditions. We find that growth in the depth and general access to financial institutions is key to enhancing the convex, increasing returns to financial development, while the development of financial markets plays a supporting role, which can, however, lead to concave, declining returns when the rate of financial market growth is too slow or too fast relative to institutional growth. Furthermore, we find that the rate at which a country develops its domestic financial sectors relative to the rate at which it becomes financially open to the global economy can be important in determining whether the convex or concave aspects of financial development are accentuated.