Interaction between economic and financial developmment

This paper presents a model of financial and economicdevelopment which assumes the consumption of real resources by the financial sector. Financialdevelopment occurs endogenously as the economy reaches a critical threshold of economicdevelopment. Compared to financial autarky, financial intermediaries allocate savings, net of their costs of operation, to more productive investments. Whenever the technology financed by intermediaries is more capital-intensive than that operated in financial autarky, the growth effect of financialdevelopment is ambiguous. As a result, financialdevelopment may be unsustainable. However, when financialdevelopment is sustainable, the credit market becomes more competitive and more efficient over time, and this could eventually contribute to economic growth. Nonetheless, given monopolistic competition in the financial sector, the level of entry into the credit market is generally inefficient. For instance, with diminishing returns to specialisation, entrants might be too few at the early stages of economicdevelopment and too many later on.