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Financial Development and Economic Growth in a Microfounded Small Open Economy Model

Bo Zhang and Peng Zhou ()
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Bo Zhang: Beijing University of Chemical Technology

No E2021/21, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: The global financial crisis since 2008 revived the debate on whether or not and to what extent financial development contributes to economic growth. This paper reviews different theoretical schools of thought and empirical findings on this nexus, building on which we aim to develop a unified, microfounded model in a small open economy setting to accommodate various theoretical possibilities and empirical observations. The model is then calibrated to match some well-documented stylized facts. Numerical simulations show that, in the long run, the welfaremaximizing level of financial development is lower than the growth-maximizing level. In the short run, the price channel (through world interest rate) dominates the quantity-channel (through financial productivity), suggesting a vital role of international cooperation in tackling systemic risk of the global financial system.

Keywords: economic growth; financial development; open economy; DSGE (search for similar items in EconPapers)
Pages: 19 pages
Date: 2021-09
New Economics Papers: this item is included in nep-cwa, nep-dge, nep-fdg, nep-isf, nep-mac and nep-opm
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