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Role Of Financial Development On Economic Growth

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Capital markets or today commonly known as stock markets have played a lesser role in investigating the role of financial development on economic growth since the researchers have always been more oriented to investigate the effect of banks. This can be explained by the fact that stock markets are a relatively new concept compared to banks. In the last three decades availability of data regarding capital markets and increase in theoretical literature suggests that well functioning stock markets can play an important role in economic development has spured research in this field. Trough instruments like diversification of risk, increased liquidity, corporate due diligence, manager control and collection and processing of important…show more content…
2) The Crowding out Hypothesis: Increase in interest rates is the result of government borrowing increase in demand for funds. Hence, more savings are transferred into financial products when this group offers higher returns than real investments. The result is decreased amount of funds available for real investment which abrupt capital formation and has detrimental effect on economic growth 3) Financial dominance hypothesis: If speculative financial activities determine economic bases like interest rates they could falsely indicate to the condition of the economy. 4) Short Term Hypothesis: Prices in financial markets react quickly to information that has affect on future expectations. Information like corporate earnings, new contracts or FDA approvals falls in this category. This in turn leads to greater short-term volatility and possible losses and appeal to short-term speculators. Because of this corporate managers listed on stock exchanges could put more importance to short-term goals instead of long-run profitability. Long-term investments are undervalued by managers since they are undervalued by participants in financial markets harming the longer profitability and economic growth in the end. 5) Financial Instability Hypothesis: states that when economy is
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