Money, Financial Intermediation and Governance
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Money, Financial Intermediation and Governance

Dino Falaschetti and Michael J. Orlando

Dino Falaschetti and Michael Orlando unify the treatment of the many deeply related topics in money and banking in this wide-ranging book. By continually building on the assumption that economic actors are maximizers, they explain how monetary and financial services, as well as related governance mechanisms, influence economic performance. In this manner, Money, Financial Intermediation and Governance not only lets readers make sense of today’s monetary authorities and financial markets, it lets them see through superficial complexities to the fundamental influences that will shape those organizations for years to come.
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Chapter 16: Financial Development and Economic Performance

Dino Falaschetti and Michael J. Orlando


INTRODUCTION I think the question, ‘Why isn’t the whole world rich?’ is the most important question facing economists. (Edward C. Prescott, quoted by Rolnick, 1996) In Parts II–IV, we argued that monetary systems strengthen economic performance by facilitating spot transactions. We now understand that, in addition, financial systems facilitate transactions across time. To the extent that such systems economize on transactions costs, they free up resources that the process of trading might have exhausted, and thus ease the flow of resources to higher-valued uses. Rather than benefiting a narrow group of financial market participants, financial development can thus expand economic opportunities more generally. We conclude the present set of chapters with a more careful evaluation of this last implication – that is, financial development strongly influences general economic opportunities. In doing so, we’ll also address this chapter’s opening quotation by arguing that, just as persistent political forces can work against efficiency in monetary systems, they can also constrain financial systems from realizing their potential. Unless a society’s political organization weakens these influences, individuals must forgo the expanded opportunities that financial development offers. Variation in societies’ success on this political dimension says a lot about why the whole world is not rich. CHANNELS FROM FINANCE TO ECONOMIC PERFORMANCE Several channels exist through which financial development can influence economic performance. Recall from this part’s motivating example that ‘cash-constrained’ firms must forgo fundamentally profitable projects (see Chapter 13). Economies that enjoy productive financial systems, however,...

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