Growth, TFP, Domestic and International Capital Flows

Background

The topic of this lesson is Growth, TFP, Domestic and International Capital Flows with Other Frictions in Financial Intermediation: Costly State Verification, Adverse Selection, and Moral Hazard. It is devoted to such concepts as financial intermediation, capitals flows, output, economic growth, and relations among others. Therefore, this lesson fits into my development and knowledge of finance and economics because it studies several economic and financial concepts and relations between them.

 

Opinions and Points of View

Following key points were discussed in the lesson:

  1. The economic development and output in the economy are determined by various factors including development of financial sector and financial intermediation. Taiwan can be considered an example of a country that developed due to financial sector development. In Taiwan, several reforms and development of the financial sector resulted in 45% of the total growth of the economy in the period from 1970 to 2010. Financial development in the economy usually leads to higher growth rates of the national income and productivity. Mechanism is as follows; when the interest rate spread becomes smaller, the national TFP increases. In its turn, the increase of TFP of the country leads to higher GDP per capita. Due to this mechanism, the development of financial sectors showed with the lower spread of interest rate, causes TFP and GDP.
  2. In the modern global economy, the imbalances in capital flows between countries are common. They can lead to economic constrains. The example is huge capital flows from China to the US and other developed countries that are considered to be among the causes of the financial crisis in 2007-2008.
  3. Adverse selection influences capital flows, too. Due to adverse selections, countries receive more capital flows. It leads to new inflows of capital from global financial markets in which the complete information is available to users. At the same time, increased capital flows can cause lower aggregate consumption because they have low marginal returns. Adverse selection also leads to higher equilibrium interest rate. Equilibrium borrowings and investment grow too. At the same time, the percentage of inefficient entrepreneurship grows. The difference between marginal return on investment and the equilibrium interest rate is negative.
  4. In one country, obstacles to trade may differ from location to location, for instance, for urban and rural areas. The areas that have fewer trade obstacles are typically more financially developed. Therefore, the government should come up with a financial regime that is beneficial for both areas (Townsend n.p.).

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New Information that I Learned

  • The level of output and economic growth of a particular economy depend on many factors. The development of financial sector and financial intermediation are among those factors. The mechanism is such. The decreased interest rate spread causes higher TFP for the country, which, in its turn, increases GDP per capita.
  • In globalized economies, the imbalances in capital flows are typical and can lead to economic crisis. Large capital flows from China to the US and other developed countries are considered to be among the reasons for global financial crisis in 2007-2008.
  • Adverse selection results in higher volumes of capital flows, but aggregate consumption and the marginal return are likely to become lower. The share of inefficient entrepreneurship grows, and the difference between marginal return on investment and the equilibrium interest rate becomes negative.
  • Even within one economy, obstacles to trade may vary in different regions, for instance, for rural and urban areas. Financial development is higher in the areas with fewer obstacles to free trade.

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Summary

I think that the lesson is interesting and useful to be considered in practice as it gives much new knowledge on economics and finance. It is useful because it studies the relationship between financial sector development, economic growth, adverse selection, and some other economic concepts.

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