This thesis investigates the relationship between economic growth and financial development in developing countries over 1988-2001. Previous studies have generally used averaged data, for both developing and developed countries, and inappropriate estimation methods. In an attempt to reach some definitive conclusions, Generalised Method of Moments dynamic estimation is used with a newly collected panel of annual data to assess the relationship. The results show that while banks performance has a negative impact on growth, stock markets positively promote growth. To reach an overall conclusion about the impact of finance on growth and to solve the problems associated with the existence of multicollinearity among the different measures of financial development, principal components analysis is used to generate new, comprehensive measures of financial development. In assessing the link between the new measures and financial development and growth, the results support the existence of an overall positive relationship. The thesis also examines the behaviour of interest rates in developing and industrialised countries using individual and panel unit root tests. The results are sensitive to the choice of the test, country and time unit.

Stock markets, banks and economic growth

This paper uses a unified analytical framework to assess, both qualitatively and quantitatively, the relevance of the different hypotheses that have been proposed to explain the real effects of exchange-rate-based stabilizations. The four major hypotheses analyzed are: (1) the supply-side effects associated with an inflation decline; (2) the perception that the exchange-rate peg is temporary; (3) the fiscal adjustments that tend to accompany the peg; and (4) the existence of nominal rigidities in wages or prices.

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Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories

Recently a number of authors have criticized the role of devaluations in traditional stabilization programs It has been argued that, contrary to the traditional view, devaluations are contractionary, and generate a decline in aggregate output In spite of the renewed theoretical interest in the possible contractionary effects of devaluations, the empirical evidence on the subject has been quite sketchy In this paper the Khan and Knight (1981)model is extended to empirically address the issue of contractionary devaluations The extended model considers the effect of money surprises, fiscal factors, terms of trade changes and devaluations on the level of real output The results obtained, using a variance components procedure on data for 12 developing countries, provide some support to the short-run contractionary devaluation hypothesis; the results obtained indicate that in the short-run a devaluation will generate a decline in aggregate output It is also found that after one year a devaluation will have an expansionary effecton output The evidence suggests that in the long run, devaluations will have no effect on output

Are Devaluations Contractionary

This paper reviews the evidence on stabilization plans in high inflation countries within a unified theoretical framework. The evidence suggests that hyperinflations have been stopped almost instantaneously with no major output costs, while stabilization programs in chronic inflation countries have resulted in an initial expansion followed by a later recession, in addition to a sustained real exchange rate appreciation and current account deficits. These outcomes turn out to be consistent with the predictions of the analytical model.

Stopping High Inflation; An Analytical Overview

The growing literature on whether devaluation has contractionary effects on output in developing countries is evaluated. The paper explores links between the exchange rate and real output within a unified, fairly general analytical framework that incorporates several of the developing country features cited in the literature. The analysis suggests that many of the arguments on both sides of the debate about contractionary devaluation require modification, that some potential effects have been ignored, and that the direction of the impact effects of devaluation on real output is ambiguous on analytical grounds.

Contractionary Devaluation in Developing Countries: An Analytical Overview

Contractionary devaluation, substitution in production and consumption, and the role of the labor market

External shocks, financial reforms, and stabilization attempts in Uruguay during 1974–1983

This paper explores the short-run relation between inflation and growth in Latin America. The topic was the subject of heated debate between structuralists and monetarists in the 1960's, but extensive empirical exploration has only begun.' The evidence presented here should provide a useful complement to the numerous studies of the relation between output, employment, and inflation in developed countries. Latin America provides a broad set of welldocumented experiments with which to test hypotheses regarding inflation, far broader in fact than the Group of Ten. To examine the relation between growth and inflation, I use a variant of the Phillips models formulated by Edmund Phelps, Robert Lucas and Leonard Rapping, and Lucas (1973). Deviations from normal output or growth rates are attributed to the difference between a reduced form of actual and expected prices, the latter being characterized by rationality, as defined below. The major conclusions obtained using this model are: 1. In Brazil, Chile before Allende, Colombia, Mexico and Peru, a small though significant relation exists between output or growth and "unexpected" inflation. This result is substantially stronger than those obtained in Robert Barro's (1974,1979) studies of Latin American inflations. 2. Ten percentage points of unexpected inflation produce about one extra percentage point of growth. This effect is statistically indistinguishable across the five countries once the different processes of monetary supply and corresponding formulation of expectations are taken into account. This result strongly supports Lucas' hypothesis that the reaction to unexpected inflation depends on the predictability of inflation, because predictability in the five cases is seen to be similar, once one allows for differences in monetary supply processes.2 This effect is also significantly smaller than those obtained by Lucas (1973) for the developed countries with more predictable inflations, confirming his hypothesis of a near vertical Phillips curve when nominal demands are unpredictable. To put it another way, this paper may be considered as an attempt to add a "third data point"-moderately inflationary countries such as Colombia, Peru and Mexicoto what Lucas (1973) refers to as "two data points"-the developed countries and the inflationary countries of Argentina and Paraguay.3 In addition, the cases of Brazil *Brown University. This paper was completed while I was a visiting scholar at the International Finance Division of the Board of Governors of the Federal Reserve System. I am grateful for the use of computer facilities at CEPAL, Brown University, and the Board of Governors, and for comments from Roque Fernandez, Robert Gregory, Herschel Grossman, Dale Henderson, Robert King and Jerome Stein, though I alone bear full responsibility for the study. The analysis and conclusions of this paper should not be interpreted as representing the views of the Board of Governors of the Federal Reserve System or members of its staff. More extensive statistical results are contained in my International Finance Discussion Paper. 'For a review of existing work, see the paper by Roque Fernandez and myself. Summaries of the structuralist view may be found in Roberto Campos, Enrique Sierra, and Susan Wachter, among others. 2Lucas uses the variance of detrended nominal demand as a measure of its predictability because he assumes that variable can be characterized by a random walk with trend. With a more complicated money supply process, predictability of inflation becomes the key variable in the reaction to unexpected inflation. 3It is worth noting that there is a slight inverse relationship between the coefficient of unexpected inflation and the variability of inflation within Lucas' developed country "data point," tending to confirm his hypothesis. Both within Lucas' (1973) sample and in Latin America, as discussed in Fernandez and myself,

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The Short-Run Relation Between Growth and Inflation in Latin America: A Quasi Rational or Consistent Expectations Approach

This paper analyzes the recent growth of government domestic debt, including central bank debt, using a new data base on government domestic debt in developing countries with large, open financial systems. On average, government domestic debt grew much faster than GDP between 1994 and 2004 and became larger than foreign debt. The rapid growth of domestic debt reflects financial crises, the growth of central bank debt and the greater attractiveness to governments of issuing domestic debt as well as the recent increase in demands for it. Both its attractiveness and the increased demands for it reflect the current benign international environment to some degree. The main risk of government debt, domestic or foreign, remains its overall size relative to a country's fiscal, financial, and political institutions. While government domestic debt can help the domestic private capital market, large domestic debt, like large external debt, has risks. For example, there can besudden stopsin the demand for domestic debt as well as in foreign lending. Governments need to be aware of the risks and burdens in domestic debt issue-crowding out small borrowers, transferring risks to banks when issuing longer maturity, fixed-interest domestic debt and reducing returns, and imposing risks on holders of pensions, annuities, and life insurance policies. Growth of central bank debt can divert central banks from pursuit of the objective of price stability.

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James A. Hanson

Papers

Contractionary devaluation, substitution in production and consumption, and the role of the labor market

External shocks, financial reforms, and stabilization attempts in Uruguay during 1974–1983

The Short-Run Relation Between Growth and Inflation in Latin America: A Quasi Rational or Consistent Expectations Approach

The Growth in Government Domestic Debt : Changing Burdens and Risks

Inflation and imported input prices in some inflationary Latin American economies