Working Paper: CEPR ID: DP17304
Authors: Daria Finocchiaro; Philippe Weil
Abstract: A growing empirical literature documents a non-monotonic relationship between finance and growth. We investigate this finding in a Schumpeterian endogenous-growth model with search frictions and congestion effects in credit and innovation markets. Financial development eases the financing of innovation but exacerbates congestion effects in R&D. Conversely, policies that promote R&D aggravate financial bottlenecks. Once general equilibrium feedback effects are taken into account, the interplay between the two congestion frictions generates a non-linear relationship between finance and productivity growth. We show that, for a calibration chosen to mimic the actual US economy, the interplay between credit and innovation frictions results in a negative impact of finance on growth. This impact is however quantitatively small – consistent with the observation that, in the last century, most developed economies have experienced a widespread expansion of the financial sector yet almost constant, or slowly declining, growth rates of GDP (save for financial crises, pandemics or wars).
Keywords: growth; finance; search frictions
JEL Codes: E40; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial development (O16) | Financing of innovation (O36) |
| Financing of innovation (O36) | Congestion in R&D markets (O36) |
| Congestion in R&D markets (O36) | Productivity growth (O49) |
| Financial development (O16) | Congestion in R&D markets (O36) |
| Financial development (O16) | Productivity growth (O49) |