recent years, many central banks have placed increased emphasis on price stability. Monetary policy—whether expressed in terms of interest rates or growth of monetary aggregates—has been increasingly geared toward the achievement of low and stable inflation. Central bankers and most other observers view price stability as a worthy objective because they think that inflation is costly. Some of these costs involve the average rate of inflation, and others relate to the variability and uncertainty of inflation. But the general idea is that businesses and households are thought to perform poorly when inflation is high and unpredictable. The academic literature contains a lot of theoretical work on the costs of inflation, as reviewed recently by Briault (1995). This analysis provides a presumption that inflation is a bad idea, but the case is not decisive without supporting empirical findings. Although some empirical results (also surveyed by Briault) suggest that inflation is harmful, the evidence is not overwhelming. It is therefore important to carry out additional empirical research on the relation between inflation and economic performance. This article explores this relation in a large sample of countries over the last 30 years.

This paper evaluates (1) whether the exogenous component of financial intermediary development influences economic growth and (2) whether cross-country differences in legal and accounting systems (e.g., creditor rights, contract enforcement, and accounting standards) explain differences in the level of financial development. Using both traditional cross-section, instrumental variable procedures and recent dynamic panel techniques, we find that the exogenous components of financial intermediary development is positively associated with economic growth. Also, the data show that cross-country differences in legal and accounting systems help account for differences in financial development. Together, these findings suggest that legal and accounting reforms that strengthen creditor rights, contract enforcement, and accounting practices can boost financial development and accelerate economic growth.

Abstract: This paper evaluates the empirical relationship between the level of financial intermediary development and (i) economic growth, (ii) total factor productivity growth, (iii) physical capital accumulation, and (iv) private saving rates. We use (a) a pure cross-country instrumental variable estimator to extract the exogenous component of financial intermediary development, and (b) a new panel technique that controls for biases associated to simultaneity and unobserved country-specific effects. After controlling for these potential biases, we find that (1) financial intermediaries exert a large, positive impact on total factor productivity growth, which feeds through to overall GDP growth; and (2) the long-run links between financial intermediary development and both physical capital growth and private saving rates are tenuous.

The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. Acknowledgements: We would like to thank Anke Höffler for research assistance in section 2 and Chris Adam, Janine Aron, Kees Burger, Bill Kinsey, Remco Oostendorp, Ritva Reinikka, Francis Teal, Steve Younger and three referees for comments. Abstract: Africa has had slow growth and a massive exodus of capital. In many respects it has been the most capital-hostile region. We review and interpret the aggregate-level and microeconomic literatures to identify the key explanations for this performance. There is a reasonable correspondence of the two sets of evidence, pointing to four factors as being important. These are a lack of openness to international trade; a high-risk environment; a low level of social capital; and poor infrastructure. These problems are to a substantial extent attributable to government behaviour and the paper includes a review of the political economy literature which addresses that behaviour

This paper -- a product of the Finance and Private Sector Development Division, Policy Research Department -- is pa't of a larger effort in the department to understand the links between the financial system and economic growth. The study was funded by the Bank's Research Support Budget under the research project "Stock Market Development and Financial Intermediary Growth" (RPO 679-53). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room N9-030, telephone 202-473-8526, fax 202-525- 1155, Internet address psintimaboagye@worldbank.org. December 1996. (44 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less tban fully pollsbed. The papers carry the names of the authors and should be cited accordingly. Tbe findings, interpretations, and conclusions expressed m tbis paper are entirely those of tbe author. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent

This paper examines the relationship between the legal system and banking development and traces this connection through to long-run rates of per capita GDP growth, capital stock growth, and productivity growth. The data indicate that countries where the legal system (1) emphasizes creditor rights and (2) rigorously enforces contracts have better developed banks than countries where laws do not give a high priority to creditors and where enforcement is lax. Furthermore, the exogenous component of banking development -- the component defined by the legal environment -- is positively and robustly associated with per capita growth, physical capital accumulation, and productivity growth.

For over a century, economists and policy makers have debated the relative merits of bank-based versus market-based financial systems. Recently, however, proponents of the legal-based view of financial development have argued that the century long debate concerning bank-based versus market-based financial systems is analytically vacuous. According to this view, the critical issue is establishing a legal environment in which both banks and markets can operate effectively. This paper represents the first broad, cross-country examination of which view of financial structure and economic growth is most consistent with the data.

Abstract: This paper examines the connection between the legal environment and financial development, and then traces this link through to long-run economic growth. Countries with legal and regulatory systems that (1) give a high priority to creditors receiving the full present value of their claims on corporations, (2) enforce contracts effectively, and (3) promote comprehensive and accurate financial reporting by corporations have better-developed financial intermediaries. The data also indicate that the exogenous component of financial intermediary development – the component of financial intermediary development defined by the legal and regulatory environment – is positively associated with economic growth.

Minnesota, respectively. The findings, interpretations, and conclusions of this paper are entirely those of the authors. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. We would like to thank Thorsten Beck for doing most of the work and Jerry Caprio for very helpful comments. 1 I.

Abstract: A growing theoretical literature describes mechanisms whereby even predictable increases in the rate of inflation interfere with the ability of the financial sector to allocate resources effectively. This paper empirically assesses these predictions. The evidence indicates that there is a significant, and economically important, negative relationship between inflation and both banking sector development and equity market activity. Further, the relationship is nonlinear. As inflation rises, the marginal impact of inflation on banking lending activity and stock market development diminishes rapidly. Moreover, we find evidence of thresholds. For economies with inflation rates exceeding 15 percent, there is a discrete drop in financial sector performance. Finally, while the data indicate that more inflation is not matched by greater nominal equity returns in low-inflation countries, nominal stock returns move essentially onefor-one with marginal increases in inflation in high-inflation economies.