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Relationship Between Finance And Economic Growth Essay Plan Notes

Economics Notes > Empirical/Contemporary Theories of Economic Growth Notes

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Finance and Growth


Relationship between financial development and economic growth is a long debated issue.


Financial instruments, markets and institutions arise to ameliorate the effects of information, enforcement and transactions costs.


How well financial systems do this influences



Savings rates


Investment decisions


Technological innovations


Steadystate growth rates

Changes in economic activity can influence financial systems with dynamic implications for growth.

Sample Essay: Financial sector development is not only important for fostering economic growth, but also for dampening volatility. The availability of external finance is positively associated with entrepreneurship and innovation. It involves improvements in producing information about possible investments and allocations of capital; monitoring firms and exerting corporate governance; trading, diversification and risk management; mobilisation and pooling of savings; and easing the exchange of goods and services. All of these functions influence the savings and investment decisions, and technological innovations throughout the economy, and hence direct economic growth. Financial intermediaries undertake the costly process of researching investment possibilities through evaluating firms, managers and market conditions. Individual savers may not have the ability to collect and process information, and thus do not use capital at its highest value. Improving resource allocation through the financial sector will therefore optimise growth. Principle Agent Problem identifies the divergence between managers and equity holders' interests. Financial infrastructure allows for arrangements to encourage incorporation, so that equity holders can ensure corporate governance is exerted effectively. The financial intermediary, or delegated monitor, economises on aggregate monitoring costs of several clients and can improve corporate governance whilst reducing credit rationing. High productivity, capital accumulation and growth ensue as a result.

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