Working Paper: CEPR ID: DP1127
Authors: Oren Sussman; Joseph Zeira
Abstract: This paper reformulates the well known financial development conjecture (FDC) and supplies some new empirical evidence in its favour. The financial development conjecture, namely, that there exist strong feedback effects between real and financial development, is described in this paper by use of the cost of financial intermediation. The theoretical part of the paper describes how specialization of banks can lead to such feedback effects, which work through the cost of financial intermediation. In the empirical part of the paper we use US cross-state data from banks' income statements to show that the cost of banking is negatively related with the level of real economic development.
Keywords: financial development; banks; economic growth
JEL Codes: E44; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| cost of financial intermediation (G20) | real economic development (O29) |
| real economic development (O29) | cost of financial intermediation (G20) |
| real economic development (O29) | bank profits (G21) |
| bank profits (G21) | entry of more banks (G21) |
| entry of more banks (G21) | average distance between banks and borrowers (G21) |
| average distance between banks and borrowers (G21) | cost of financial intermediation (G20) |
| cost of financial intermediation (G20) | investment and growth (O16) |
| wage effect (J31) | cost of monitoring (E64) |
| cost of monitoring (E64) | cost of financial intermediation (G20) |