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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.

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.

In recent years, the number of downgrades in corporate bond ratings has exceeded the number of upgrades, leading some to conclude that the credit quality of U.S. corporate debt has declined. However, an alternative explanation of this apparent decline in credit quality is that the rating agencies are now using more stringent standards in assigning ratings. An ordered probit analysis of a panel of firms from 1978 through 1995 suggests that rating standards have indeed become more stringent, implying that at least part of the downward trend in ratings is the result of changing standards. BOND RATINGS PLAY A KEY ROLE in corporate financing and investment decisions. A corporation that can issue higher rated bonds usually receives better terms than one that can issue only lower rated bonds. By law or policy, some investors can purchase only bonds with an investment-grade rating, a restriction which in some asset pricing models would affect the relative prices of financial assets.

severe bouts of financial instability that have had devastating impacts on crisis countries such as Mexico (in which GDP growth fell from above 4 percent in 1994 before the crisis to negative 6 percent

ews expressed are those of the authors and do not necessarily reflect those of the Bank of England. We would like to thank Clive e, Danny Quah, Peter Westaway, Tony Yates, an anonymous referee and the participants of the Bank’s Friday workshop serie ents. Bruce Deville, Simon Frew, and Cheryl Hunter provided invaluable research assistance. by the Bank of England, London, EC2R 8AH to which requests for individual copies should be addressed: envelopes should be on of the Publications Group. (Telephone 0171-601 4030.)

This paper puts forward a specifically Minskyan account of the road to the financial crisis in South East Asia (1997/1998), extending his Financial Instability Hypothesis to the case of the open `liberalised ’ economy. The analysis suggests that threats to growth and employment emanating from the financial sector, which Minsky identified in the closed economy setting, are much intensified in open, liberalised and, especially, developing economies. Rival explanations of the crisis are examined and rejected in favour of the extended Minskyan explanation. Policy implications are derived and discussed. KEYWORDS:

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We apply vector autoregression (VAR) to firm-level panel data from 36 countries to study the dynamic relationship between firms' financial conditions and investment. We argue that by using orthogonalized impulse-response functions we are able to separate the 'fundamental factors' (such as marginal profitability of investment) from the 'financial factors' (such as availability of internal finance) that influence the level of investment. We find that the impact of the financial factors on investment, which we interpret as evidence of financing constraints, is significantly larger in countries with less developed financial systems. Our finding emphasizes the role of financial development in improving capital allocation and growth.