Archive for September 24th, 2007

Impact of financial systems on economic cycles

September 24, 2007

Every country has different financial system. Even if they have a market based system the degree of how much markets intermediate savings differ.

This summaryfrom IMF is an excellent one which explains how different financial systems efect various economic cycles. The shorter versionis also available. Basically it is a part of IMF’s World Economic Outlook where apart from the general outlok it discusses some important research findings.

This research focuses on developed economies and analyses whether a system is more at arms’ length or less. Arms length financial transaction means either it is between 2 unaffiliated parties or even if it is between 2 related parties (say between 2 subsidiaries) it is done in a manner as if they are unrelated (i.e. fair pricing etc). The opposite of it is relationship based fin system in which transactions are done on the basis of relationship. Rajan and Zingales have another excellent anslysis of the two kinds of systems.

The consensus is that most countries are and should move towards arms length fin systems as it is more transparent and thereby efficient. Hence the paper focuses on which advanced countries have more arms’ length systems or less and their impact on economy.

The broad ideas that emerge are:

1) Differences in financial systems among advanced economies affect the behavior of economic cycles.

2) Households in so-called “arm’s length” financial systems (including the United Kingdom and the United States) can borrow more to support consumption, but higher debt makes them more vulnerable to rising interest rates and declining asset prices.

3) The more “relationship-based” financial systems in Europe are less well equipped to transfer resources from declining to growing economic sectors,thereby hampering efforts to boost productivity and respond to technological change and globalization.

Nice study. Highly recommended.

Assorted Links

September 24, 2007

1. Ajay Shah has done an excellent analysis of the Fed rate cut and its impact. He also points to some good analysis on Maharashtra lagging behind.

2. Rodrik starteda discussion asking the readers which economists they wanted to blog. His listshowed most wanted Stiglitz and Acemoglu to blog. Tyler Cowen also asks the same question. Well we don’t have his list as of now.

3. WSJ has some more on Greenspan.

4. Mankiw on Helicopter Ben.

5. Rodrik points to a paper on trade. Looks quite a food for thought.

6. An excellent FAQ on money creation from James Hamilton in Econbrowser. Phew what a blog this.

7. ET points it is now the turn of EAC to study the impact of sub-prime on Indian economy. I don’t know why we wake up so late. All along, our policymakers have followed what Fed has to say. Earlier Fed felt it was ok, hence no action. Now as Fed reduced rates, we decide to do a report.

8. ET debates do we need an exchange for SMEs? Yes we do.

9. Now, I think MIFC report makes sense.


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