Is there any relationship between financial system and development?
Walter
Lombard Street: A Description of Money Market
Bagehot in his book published in 1873 talked about the role of financial institutions in economic development in England.
J.M.
Keynes in his book-General Theory
of
Employment,
Interest
and
Money
the and
written in 1936 emphasised on relationship between finance economic development.
Is there any relationship between financial system and development?
Joseph Schumpeter in his book-Theory of Economic Development published in 1934 talks about the relationship between credit (a form of finance) and innovation which causes economic development.
"The banker stands between those who wish to form new combinations and the possessors of productive means. He is essentially a phenomenon of development, though only when no central authority directs the social process. He makes possible the carrying out of new combinations, authorises people, in the name of the society as it were, to form them. He is the ephor of the exchange economy.”
Is there any relationship between financial system and development?
Schumpeter further said, “The relation between credit creation by banks and innovation is fundamental to the understanding of the capitalist engine." Robert G King, and Ross Levine (1993) “Finance and Growth: Schumpeter Might Be Right.” Quarterly Journal of Economics 108 (August): 716–37.
Is there any relationship between financial system and development?
Alexander
Gerschenkron
in
his
book-
Economic Backwardness and Historical Perspective: A Book of Essays published
in 1962 talked about the necessity of financial institutions to kick start the industrial development.
Rondo
Cameron in his book- Banking
in Early Stages of Industrialisation: a Study in Comparative Economic History
published in 1967 emphasised on the financial system and its role on economic development in developed countries.
Is there any relationship between financial system and development?
Robinson,
J. (1952), „The Generalisation of the General Theory‟, in her book- The Rate of Interest and Other Essays said :
“...Where enterprise finance follows.”
leads,
What is economic development?
It
indicates a situation of growing betterment of individuals in the society. In economics it relates to material well-being which is determined by production of goods and services. development refers to growth of GDP with its balanced distribution in the society.
Economic
Examples of role of finance in economic development.
Financial
system through bringing together the savers and investors promote the production of goods and services. flows to agriculture
(a)Financial sector.
(b)Financial flows to industrial sector. (c)Financial flows to service sector. (d)Financial flows to speculative stock markets?
Theories of relationship between finance and economic development
1. 2. 3. 4. 5.
Prior savings theory Credit creation theory Theory of forced savings Financial regulation theory Financial liberalisation theory
Prior Savings Theory
This
theory regards saving as a prerequisite or a determinant of investment. It holds that all savings in the economy can find investment outlets. to this theory if Investments exceed savings then it generates inflation in the economy. there should be an emphasis on mobilisation of savings from each nook and corner of the country to raise the availability of savings to finance higher level of investments.
According
Therefore
Loanable Funds Theory as part of prior saving theory
r
I
S S1 E
r1 E1 r2
S1=I1 S2=I2
S, I
Financial intermediation and production possibility frontiers
X
PPF
PPF1 Y
The role of financial intermediaries in shifting the PPFs
They
reduce the cost for searching investment opportunities for individuals. verify the soundness investment projects. the use which it was lent. borrowers interest. of of the for
They
Monitoring
funds
Enforcement
of rules to ensure the repay the loans with
The role of financial intermediaries in shifting the PPFs
They
perform as the source of development by adopting the following transformation services:
theory accepts that savings do not constraint the investments given the banking system. theory is based on the concept of inside-money.
This
This
theory can be understood by looking at the role of banks in creation of demand deposits in a fractional reserve system with multiple banks.
and Schumpeter were supporters of this theory. the main
Kalecki
Theory of Forced Savings
This
theory establishes that investments is financed by
ex-ante ex-post
savings.
It
was argued by J.M. Keynes and James Tobin. rather saving. is not determined by savings investment determines its own
Investment
If
there is monetary expansion to finance investment over saving then if there is excess capacity in the economy it will generate income and therefore matching savings.
Theory of Forced Savings
At full employment rise in investment will increase inflation that will reduce the real interest rates and this cause shift in portfolio-pattern causing people to use more capital intensive techniques which causes output and savings to rise. This is called portfolio or Tobin‟s effect. At full employment if investment increases it leads to inflation which benefits the capitalists and that causes there income to grow and therefore savings. This is know as distribution effect.
Financial Regulation Theory
This
theory is primarily based on the article written by G.A. AKERLOF (1970) “The Market for Lemons: Quality Uncertainty and the Market Mechanism.” Quarterly Journal of Economics, Vol. 84 (1970), pp. 488–500 and Joseph Stiglitz and A. Weiss(1981), “Credit Rationing in Markets with Imperfect Information”,
American Economic Review, Vol. 71, pp. 393-410.
Both
were awarded Nobel Prize with A. Michael Spence in 2001.
Financial Regulation Theory
There is imperfect information in the market. If there is no control over interest rates then bad borrowers will replace good borrowers ultimately to cause the failure of repayments. there is too much competition that will lead to frequent change of the lenders which will create greater degree of asymmetric environment in the economy.
If
Financial Liberalisation Theory
Ronald I. McKinnon(1973), Money & Capital in
Economic Development.
E.S. Shaw(1973), Financial Deepening in Economic Development.
McKinnon and Shaw are main proponents of the Financial Liberalisation Theory.
They argued against the financial regulation theory by calling the regulated economies as financially repressed economies.
Indicators of Financial Repression
Lower
savings and inefficient investments. of indiscriminate distortions:
in Interest rates. in savings. in efficient investments. in better financial services.
More
options for saving mobilisation.
Innovation
of financial instruments which make the payment system more efficient and better suited for customers.
What is financial development?
Finance Inter-relation Ratio (FIR): Ratio of Financial assets to physical assets. New Issue Ratio (NIR): Ratio of primary issues to physical capital formation.
Intermediation Ratio (IR): Ratio of secondary issues to Primary issues.
Ratio of Money supply to total GDP. Lower information costs also imply financial development. Greater openness of financial system is an indicator of larger financial assets.
What is Flow of Funds (FOF) Accounts?
FOF represents systematic record of net transactions involving financial instruments during a given period of time. All the participants in financial activities be grouped into few sectors (in India it six); and all the financial claims can grouped into few instruments (in India it ten). can is be is
Following the system of double entry bookkeeping in financial accounting, the transactions between participants could be treated in quadruple entry form. The FOF is prepared usually quarterly annually and presented in a matrix form. or
What is Flow of Funds (FOF) Accounts?
Row-wise
entries show flow of funds into different sectors; while column-wise entries show receipts from various sectors. reveals the overall surplus or deficit of a sector. also expresses changes in assets and liabilities of different sectors. represents a comprehensive picture of an economy where policy makers can identify where to put funds and what kind of financial policy to follow during different business climates.
FOF
FOF
FOF
What is Flow of Funds (FOF) Accounts?
FOF
is also presented in terms of sectors and forms of instruments which bring up the change in assets and liabilities of sector during a period of time. convention is to treat increase in assets of a sector as uses of funds and increase in liabilities as sources of funds. of funds in India.docx