The author argues that the preponderance of theoretical reasoning and empirical evidence suggests a positive first order relationship between financial development and economic growth. There is evidence that the financial development level is a good predictor of future rates of economic growth, capital accumulation, and technological change. Moreover, cross-country, case-style, industry level and firm-level analysis document extensive periods when financial development crucially affects the speed and pattern of economic development. The author explains what the financial system does and how it affects, and is affected by, economic growth. Theory suggests that financial instruments, markets and institutions arise to mitigate the effects of information and transaction costs. A growing literature shows that differences in how well financial systems reduce information and transaction costs influence savings rates, investment decisions, technological innovation, and long-run growth rates. A less developed theoretical literature shows how changes in economic activity can influence financial systems. The author advocates a functional approach to understanding the role of financial systems in economic growth. This approach focuses on the ties between growth and the quality of the functions provided by the financial systems. The author discourages a narrow focus on one financial instrument, or a particular institution. Instead, the author addresses the more comprehensive question: What is the relationship between financial structure and the functioning of the financial system?

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Financial development and economic growth : views and agenda

Heteroskedasticity biases tests for contagion based on correlation coefficients. When contagion is defined as a significant increase in market comovement after a shock to one country, previous work suggests contagion occurred during recent crises. This paper shows that correlation coefficients are conditional on market volatility. Under certain assumptions, it is possible to adjust for this bias. Using this adjustment, there was virtually no increase in unconditional correlation coefficients (i.e., no contagion) during the 1997 Asian crisis, 1994 Mexican devaluation, and 1987 U.S. market crash. There is a high level of market comovement in all periods, however, which we call interdependence.

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No Contagion, Only Interdependence: Measuring Stock Market Comovements

This paper examines stock market co-movements. It begins with a discussion of several conceptual issues involved in measuring these movements and how to test for contagion. Standard tests examine if cross-market correlation in stock market returns increase during a period of crisis. The measure of cross-market correlations central to this standard analysis, however, is biased. The unadjusted correlation coefficient is conditional on market movements over the time period under consideration, so that during a period of turmoil when stock market volatility increases, standard estimates of cross-market correlations will be biased upward. It is straightforward to adjust the correlation coefficient to correct for this bias. The remainder of the paper applies these concepts to test for stock market contagion during the 1997 East Asian crises, the 1994 Mexican peso collapse, and the 1987 U.S. stock market crash. In each of these cases, tests based on the unadjusted correlation coefficients find evidence of contagion in several countries, while tests based on the adjusted coefficients find virtually no contagion. This suggests that high market co-movements during these periods were a continuation of strong cross-market linkages. In other words, during these three crises there was no contagion, only interdependence.

No Contagion, Only Interdependence: Measuring Stock Market Co-Movements

A paradigm is presented in which both the extent of financial intermediation and the rate of economic growth are endogenously determined. Financial intermediation promotes growth because it allows a higher rate of return to be earned on capital, and growth in turn provides the means to implement costly financial structures. Thus financial intermediation and economic growth are inextricably linked in accord with the Goldsmith-McKinnon-Shaw view on economic development. The model also generates a development cycle reminiscent of the Kuznet hypothesis. In particular, in the transition from a primitive slow-growing economy to a developed fast-growing one, a nation passes through a stage in which the distribution of wealth across the rich and poor widens.

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Financial Development, Growth, and the Distribution of Income

The aim of this paper is to examine the role of gold in the global financial system. We test the hypothesis that gold represents a safe haven against stocks of major emerging and developing countries. A descriptive and econometric analysis for a sample spanning a 30 year period from 1979-2009 shows that gold is both a hedge and a safe haven for major European stock markets and the US but not for Australia, Canada, Japan and large emerging markets such as the BRIC countries. We also distinguish between a weak and strong form of the safe haven and argue that gold may act as a stabilizing force for the financial system by reducing losses in the face of extreme negative market shocks. Looking at specific crisis periods, we find that gold was a strong safe haven for most developed markets during the peak of the recent financial crisis.

Is Gold a Safe Haven? International Evidence

Much of the current debate on reforming the international financial architecture is aimed at reducing the risks of contagion best defined as a significant increase in cross market linkages after a shock to an individual country (or group of countries). This definition highlights the importance of other links through which shocks are normally transmitted including trade and finance. During times of crisis, the ways in which shocks are transmitted do seem to differ, and these differences appear to be important. Empirical work has helped to identify the types of links and other macroeconomic conditions that can make a country vulnerable to contagion during crisis considerations periods, although less is known about the importance of microeconomic and institutional factors in propagating shocks. Empirical research has helped to identify those countries that are at risk of contagion as well as some, albeit quite general, policy interventions that can reduce risks.

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Contagion: Understanding How It Spreads

The financial turbulence that hit many East Asian countries in 1997, and then spread to other parts of the world, continued unabated in the fall of 1998. Russia defaulted on its debt as confidence in global financial markets evaporated. The turmoil next hit developed countries’ capital markets, dramatically altering the (relative) pricing of many financial instruments, which in turn accelerated the collapse of Long-Term Capital Management (LTCM), a large U.S. hedge fund. The turmoil subsequently affected Brazil, where it created large uncertainties about that country’s ability to rollover its public sector debt, thus spilling over into other Latin American emerging markets and elsewhere (see further World Bank, 1999 and International Monetary Fund, 1999).

Contagion: Why Crises Spread and How This Can Be Stopped

The future emergence of a European monetary zone is set to transform the configuration of the international monetary system and the roles of the dollar, the Euro and the yen within this system. This book addresses this issue with discussion of:
* exchange rate policies pursued in the principal Asian countries
* the measurement of equilibrium exchange rates for these countries
* the maintenance of the dollar peg by Asian currencies
* the absence of a trend to monetary regionalism based on the yen
* the outlook of regional monetary co-operation
* the outlook of regional monetary co-operation
Case studies pay particular attention to Korea, Taiwan, Singapore and Thailand.

Exchange Rate Policies in Emerging Asian Countries

Korean Growth Policy

This path-breaking comparative study of the economies of Japan, Korea, and Taiwan analyses the evolution of the financial systems of each country in relation to their last four decades of dynamic economic growth. Each country study is addressed in two chapters, the first covering macroeconomic aspects of the financial system and the second chapter focusing on commercial banking. The analysis shows how financial development has occurred in two distinct phases. Initially interest rates were regulated to remain below market levels, entry of new financial institutions was restricted, financial markets were segmented, and domestic finance was insulated from world financial markets. The second phase has seen a steady, if sometimes slow, removal of these restrictions. This liberalization has meant regulation now focuses on prudential measures for system safety while financial resources are increasingly allocated through the marketplace. The evaluation of the financial development of Japan, Korea and Taiwan provides significant insights for economists and policymakers. In particular, there are many lessons for less developed markets and transforming socialist economics.

Yung Chul Park

Papers

Contagion: Understanding How It Spreads

Contagion: Why Crises Spread and How This Can Be Stopped

Exchange Rate Policies in Emerging Asian Countries

Korean Growth Policy

The Financial development of Japan, Korea, and Taiwan : growth, repression, and liberalization