Financial Intermediation and Economic Growth

Financial Intermediation and Economic Growth

Due to today's high degree of opening towards free trade, more flexible transactions in the financial markets, the increasing interest in integration, forming unions and various meetings organized aiming at the facilitating the trade and financial conditions, the forgotten debate arisen mainly by Goldsmith and McKinnon from about two decades has sparkled the interest of many economist and politicians again. The reason according to M. Pagano is the further research and discoveries in the particularities of endogenous growth models, whereas according to M. Aziakpono the integration of global financial markets plays a role. The crucial fact is that despite many studies, many of which are mentioned and very detailed analyzed in the paper R. Levine, a final conclusion with certainty cannot be reached upon the link between the financial markets and the economic growth of particular countries.

Firstly, in his paper, M. Pagano shows how financial development can affect growth by using the ‘AK' model with an equation for the steady state growth. In this model he explains how the proportion of savings funneled through firms and the improvement of the allocation of capital through collective information for alternatives and risk sharing lead to changes in the saving rate can affect growth in ambiguous way. This ambiguity is due to the differences in the specific market where financial development occurs like insurance, households borrowing and particularly the case of liberalization of the consumer credit or mortgage markets which nowadays have a negative effect on the savings and growth, and lastly the unclearness with respect to the interest rate effects. Accordingly, he concludes that financial development, which is also determined by public policy, and growth are jointly determined and that they have in most of the cases positive correlation, but of course this does not hold always as this depends on the specific market of the economy itself. In essence, his work shows and summarizes most of the outcomes and main features which other researchers have come up with.

Furthermore, a more detailed view of the exact relationship between these two variables is better explored in the paper of R. Levine. Chiefly, he analyzes the effect of different variables and situation of markets which can play a crucial role in forming a link between the financial development and growth. So, firstly two ways how the functioning of the financial market may affect the growth are being analyzed: either through capital accumulation or technological innovation. The core work of financial markets in reducing