Monetary policy and financial market evolution

Monetary policy ; Financial markets

Equity markets, transaction costs, and capital accumulation

There is a close, if imperfect, relationship between the effectiveness of an economy's capital markets and its level (or rate of growth) of real development. This may be because financial markets provide liquidity, promote the sharing of information, or permit agents to specialize. There is literature about how these functions help increase real activity, but surprisingly little literature predicting how the volume of activity in financial markets relates to the level or efficiency of an economy's productive activity. The authors address this question: how does the efficiency of an economy's equity market -- as measured by transaction costs -- affect its efficiency in producing physical capital and, through this channel, final goods and services? The answer: As the efficiency of an economy's capital markets increases (that is, as the transaction costs fall), the general effect is to cause agents to make longer-term -- hence, more transction-intensive -- investments. The result is a higher rate of return on savings and a change in its composition. These general equilibrium effects on the composition of savings cause agents to hold more of their wealth in the form of existing equity claims and to invest less in the initiation of new capital investments. As a result, a reduction in transaction costs can cause the capital stock either to rise or fall (under scenarios described in the paper). Further, a reduction in transaction costs will typically alter the composition of saving and investment, and any analysis of the consequences of such changes must take those effects into account.International Terrorism&Counterterrorism,Economic Theory&Research,Environmental Economics&Policies,Payment Systems&Infrastructure,Banks&Banking Reform,Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,International Terrorism&Counterterrorism,Trade and Regional Integration

Unemployment, migration, and growth

Economic development is typically accompanied by a very pronounced migration of labor from rural to urban employment. This migration, in turn, is often associated with large scale urban underemployment. Both factors appear to play a very prominent role in the process of development. We consider a model in which rural-urban migration and urban underemployment are integrated into an otherwise conventional neoclassical growth model. Unemployment arises not from any exogenous rigidities, but from an adverse selection problem in labor markets. We demonstrate that, in the most natural case, rural-urban migration - and its associated underemployment - can be a source of multiple, asymptotically stable steady state equilibria, and hence of development traps. They also easily give rise to an indeterminacy of perfect foresight equilibrium, as well as to the existence of a large set of periodic equilibria displaying undamped oscillation. Many such equilibria display long periods of uninterrupted growth and rural-urban migration, punctuated by brief but severe recessions associated with net migration from urban to rural employment. Such equilibria are argued to be broadly consistent with historical U.S. experience.Unemployment

Knowledge, Technology Adoption and Financial Innovation

Why are new financial instruments created? This paper proposes the view that financial development arises as a response to the contractual needs of emerging technologies. Exogenous technological progress generates a demand for new fi-nancial instruments in order to share risk or overcome private information, for example. A model of the dynamics of technology adoption and the evolution of financial instruments that support such adoption is presented. Early adoption may be required for financial markets to learn the technology; once learned, finan-cial innovation boosts adoption further. Financial learning emerges as a source of technological diffusion. The analysis identifies a causality link from technology to finance which is nonetheless consistent with empirical findings of a positive effect of current financial development on future growth

An Econometric Study of Hours and Output Variation with Preference Shocks.

This paper investigates preference shocks, which may be interpreted as deriving from shocks to household production or changes in relative prices, as a mechanism for generating hours variation within a one-sector stochastic optimal growth model without intertemporal substitution or indivisibilities. Maximum likelihood estimates of the preference parameters are presented, along with statistics summarizing simulation of the estimated model. Comparison with postwar U.S. data shows that this model generates sufficient variation in hours relative to productivity, and in consumption relative to output, as well as predicting a negative correlation between hours and productivity. Copyright 1992 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Financial Intermediation and Endogenous Growth.

An endogenous growth model with multiple assets is developed. Agents who face random future liquidity needs accumulate capital and a liquid, but unproductive, asset. The effects of introducing financial intermediation into this environment are considered. Conditions are provided under which the introduction of intermediaries shifts the composition of savings toward capital, causing intermediation to be growth promoting. In addition, intermediaries generally reduce socially unnecessary capital liquidation, again tending to promote growth. Copyright 1991 by The Review of Economic Studies Limited.