Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Tue, 06 Sep 2011

Importance of Financial Markets

After the global financial crisis, many people started thinking that financial markets are evil. So it is nice to see several papers in quick succession arguing that financial markets are more important than banks.

Asli Demirguc-Kunt, Erik Feyen, and Ross Levine presented a paper at a World Bank conference in June entitled “Optimal Financial Structures and Development: The Evolving Importance of Banks and Markets”. They present strong empirical evidence to show that as countries grow richer and become more sophisticated, they need markets more than banks. The optimal financial structure becomes more market based at higher levels of income. Deviations from this optimal structure lead to slower growth.

This month, Julien Allard and Rodolphe Blavy published an IMF working paper entitled “Market Phoenixes and Banking Ducks: Are Recoveries Faster in Market-Based Economies?” in which they argue that “market-based economies experience significantly and durably stronger rebounds than the bank-based ones” They go on to state that “because the financial structure of economies matters, structural policies to deepen financial markets so that they can effectively complement banking sectors are useful. This suggests that policies that would stifle the development of financial markets after the crisis would be misguided.” Of course, Allard and Blavy also emphasize that policy makers must enhance the stability of financial markets as well as reduce rigidities in the real economy.

Closed related is a paper by Stephen Cecchetti, M S Mohanty and Fabrizio Zampolli presented at the Jackson Hole Symposium late last month entitled “The real effects of debt”. Cechetti et al argue that “At moderate levels, debt improves welfare and can enhance growth. But high levels can be damaging.” For example, when corporate debt goes beyond 90% of GDP, it becomes a drag on growth. This appears to me to suggest that deepening of equity markets is more important than the development of banks beyond a certain stage of development.

Posted at 21:21 on Tue, 06 Sep 2011     5 comments     permanent link


Eashwar wrote on Wed, 07 Sep 2011 10:25

Re: Importance of Financial Markets

Im a failed entrepreneur and found my calling as a trader - I trade for a living - that disclosed I feel the governments/central banks and their policies are more focused on how the markets will react or what the market wants than what they should do - Market focused or market driven policy making - Is that the right way ahead ? LONG LIVE THE MARKETS

Anonymous wrote on Thu, 08 Sep 2011 09:41

Re: Importance of Financial Markets

I think the economies with strong markets are fast to rebound, but I feel they are also the one to strongly dive in case of problems. I feel the banking system gets more stability to the entire volatile markets. They both hence are strongly interdependent and require to be present in right proportions. However, what is the right proportion is a tricky question.

fcfutures wrote on Fri, 09 Sep 2011 00:35

Re: Importance of Financial Markets

market Economies are definitely more efficient. Banks have proven over and over they are too beurocratic to repond.

credit card wrote on Sun, 08 Jan 2012 00:56

Re: Importance of Financial Markets

Financial markets have always been and add on to any kind of business. Market Economic Policies are much more better and efficient as compared to any other way of trading. Banks and their banking system are not competent to enhance stability of the financial markets.

prepaid card wrote on Mon, 09 Jan 2012 16:42

Re: Importance of Financial Markets

As such its a fact that market economic policies are made wiser with focused goal.