Reassessing the impact of finance on growth, BIS Working Papers 381 - Assignment Example

Reassessing the impact of finance on growth, BIS working paper 381 December 10, Reassessing the impact of finance on growth, BIS working paper 381 Summary of main results Cecchetti and Kharroubi, authors of the article, offer a traditional theoretical underpinning to the relationship financial sector and economic growth that led to the perception that growth in the financial sector is directly proportional to economic growth. This perspective contributed to the earlier calls for deregulation of the financial sector in order to facilitate economic growth.

Recent trends in major economies have however indicated contrary results and the study developed an empirical approach to understanding the accurate relationship between size and growth of the banking sector and state of economy. Even though growth in the financial sector is good, too much of it reduces its value and the study further notes that excessive growth is detrimental to the economy. Many theoretical assumptions, such as effects of growth in the financial sector on reducing costs, improving investments, and managing resource distribution and risks, may however downplay these positions.

The real consequences of booms in the financial sector, like in other sectors, however become evident after a burst that follows a boom to support detrimental effects of growth in the financial sector. The empirical study into the report investigated 50 countries from both developed and developing economies over the past 30 years. Factors such as the ratio of private credit to GDP and the proportion of total employment that financial sector accounts for, measure the sector’s size while volume of credit growth, relative to GDP, measured financial sector development (Cecchetti and Kharroubi 2012, p. 1, 2). The average GDP-per-worker growth that private credit contributes is one of the indicator results to the effects of growth in the financial sector on the economy.

The measure increases from the first up to the third quarter but then decreases at the fourth quarter, and this shows that excess contribution of the financial sector to the economy through credit facilities becomes detrimental at high levels. The curve turns at 100 percent of GDP by credit. The trend in effects of credit facilities is further consistent but not monotonic and the relationship between the two variables is significant, based on regression analysis results. Measuring the effects, using bank credit instead of total credit is an alternative measure and confirms the results, though with the turning point at 90 percent of GDP.

Regression analysis confirms significance and the results note that some countries, especially developed countries, are above this level and therefore viable to adverse effects of growth in the economic sector. An almost similar trend of effects of financial sector growth on the economy is reported with the sector’s share of employment as an indicator. At low levels of the sector’s contribution to total employment, an increase in contribution has positive effects on economic growth but this starts to decline beyond some point.

Regression analysis with controls identifies significance of the relationship. Most of the studied countries are however bellow the optimal level of the sector’s contribution to total employment at which its increase become detrimental. The real effects of financial sector growth on GDP is however negative. Growth in the sector, based on percentage contribution by employment, is inversely proportional to economic growth. Competition that the financial sector offers to the economy explains the results (Cecchetti and Kharroubi 2012, p. 2-16). The authors’ major assumption is that derived utility diminishes with level of supply.

This is consistent with the law of diminishing marginal utility that explains a gradual decline in marginal utility with increase in supply. It develops the hypothesis that growth in the financial sectors does not induce economic growth after some level. The study implemented a survey design in which existing data was collected on sampled countries. Trends in financial sector and trends in GDP were the identification assumptions and were restricted to sampled countries from both developing and developed populations.

Results imply that care should be taken to regulate size and growth of the financial sector with the objective of facilitating economic growth (Cecchetti and Kharroubi 2012, p. 2-16). Critics and drawbacks of the paper and suggested ways for improvements The authors develop significant knowledge base for policy makers towards informed decisions in promoting economic growth. Identification of an optimum level for size of financial sector towards economic growth shows that identification of this point for each country is necessary, achieving this point, and minimizing the sector’s growth after this point is beneficial.

This is because of the developed significant relationship between the sector’s growth and economic growth. The major drawback to the study is lack of complete data on the study’s variables and this establishes reliability concerns over the developed models and conclusion. A quasi-experimental design is therefore proposed for managing the data scarcity. The design would measure the variables from sampled countries over a selected period instead of relying on existing databases (Cottrell and McKenzie 2010, n.p.).

Reference list Cecchetti, S and Kharroubi, E 2012, Reassessing the impact of finance on growth, Bank of International Settlements, Retrieved December 10, 2013, < http://www.bis.org/publ/work381.pdf>. Cottrell, R and McKenzie, J 2010, Health promotion & education research methods: Using the five chapter thesis/dissertation model, Jones & Bartlett Publishers, Sudbury.