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Financial Deepening and Economic Growth

Bhattarai, Keshab (2013): Financial Deepening and Economic Growth.

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Abstract

A Venn diagram is used to show the efficient allocation of resources in terms of the core of Shapley-Shubik games and general equilibrium models. These concepts are applied to study the role of real finance in growth with and endogenous, cash in advance, money in utility function and applied dynamic general equilibrium model of Germany, France and UK. Computations of the general equilibrium model confirms the over financing hypothesis. The actual financial deepening was 3.5, 2.4 and 5.1 times more than optimal financial deepening for France, Germany and the UK respectively. This explains the wide-spread impacts of financial crises on growth and employment in these economies that was observed after the 2008 recessions. Shocks in financial deepening ratio cause massive macroeconomic fluctuations. Smooth and sustainable growth of the economy requires adoptions of the separating equilibrium in line of Miller-Stiglitz-Roth mechanisms to avoid the problem of asymmetric information in process of financial intermediation.

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