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Financial Cycles and the Real Economy

Financial Cycles and the Real Economy

Lessons for CESEE Countries

Edited by Ewald Nowotny, Doris Ritzberger-Grünwald and Peter Backé

What is the link between the financial cycle - financial booms, followed by busts - and the real economy? What is the direction of this link and how salient is this connection? This unique book examines these fundamental questions and offers a paramount contribution to the debate surrounding the recent financial and economic crisis.

Chapter 13: The finance–growth nexus: evidence from ten new EU members

Guglielmo Maria Caporale, Christophe Rault, Anamaria Sova and Robert Sova

Subjects: economics and finance, financial economics and regulation, money and banking


The linkage between financial development and economic growth has been extensively analysed in the literature. Most empirical studies conclude that the former, together with a more efficient banking system, accelerates the latter (Levine, 1997, 2005; Wachtel, 2001). Levine (2005) suggests that financial institutions and markets can foster economic growth through several channels, that is, by: (1) easing the exchange of goods and services through the provision of payment services; (2) mobilizing and pooling savings from a large number of investors; (3) acquiring and processing information about enterprises and possible investment projects, thus allocating savings to their most productive use; (4) monitoring investment and carrying out corporate governance; and (5) diversifying, increasing liquidity and reducing inter-temporal risk. Each of these functions can influence saving and investment decisions and hence economic growth. Since many market frictions exist and laws, regulations and policies differ markedly across economies and over time, improvements along any single dimension may have different implications for resource allocation and welfare depending on other frictions in the economy. In the Central and Eastern European countries (CEECs) reforming the banking sector was the first crucial step towards financial development. From the 1990s foreign banks were allowed to enter the market, rapidly acquired a majority share in most CEEC banks and made the sector more competitive, with positive effects on growth. However, real convergence has still not been achieved.

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