FEDERAL RESERVE BANK OF ST. LOUIS R EVIEW JULY/AUGUST 2003 VOLUME 85, NUMBER 4 Finance and Real Economic Activity Proceedings of the Twenty-Seventh Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis Monetary Policy and Financial Market Evolution Valerie R. Bencivenga and Bruce D. Smith More on Finance and Growth: More Finance, More Growth? Ross Levine Equity Market Liberalization in Emerging Markets Geert Bekaert, Campbell R. Harvey, and Christian T. Lundblad Historical Perspectives on Financial Development and Economic Growth Peter L. Rousseau The Real Effects of U.S. Banking Deregulation Philip E. Strahan Life-Cycle Dynamics in Industrial Sectors: The Role of Banking Market Structure Nicola Cetorelli Commentaries Franklin Allen Eugene N. White Luigi Zingales David C. Wheelock Peter Blair Henry Raghuram G. Rajan Contents Volume 85, Number 4 R EVIEW 1 Contributing Authors Director of Research 3 Editor’s Introduction Robert H. Rasche Deputy Director of Research Cletus C. Coughlin Review Editor Finance and Real Economic Activity William T. Gavin 7 Monetary Policy and Financial Market Research Economists Evolution Richard G. Anderson James B. Bullard Valerie R. Bencivenga and Bruce D. Smith Michael J. Dueker 27 Commentary Thomas A. Garrett R. Alton Gilbert Franklin Allen Hui Guo Rubén Hernández-Murillo Kevin L. Kliesen 31 More on Finance and Growth: More Christopher J. Neely Finance, More Growth? Michael T. Owyang Michael R. Pakko Ross Levine Jeremy M. Piger 47 Commentary Patricia S. Pollard Frank A. Schmid Luigi Zingales Daniel L. Thornton Howard J. Wall David C. Wheelock 53 Equity Market Liberalization in Emerging Markets Managing Editor George E. Fortier Geert Bekaert, Campbell R. Harvey, and Christian T. Lundblad Assistant Editor Lydia H. Johnson 75 Commentary Graphic Designer Peter Blair Henry Donna M. Stiller Review is published six times per year by the Research Division of the 81 Federal Reserve Bank of St. Louis and may be accessed at our new Historical Perspectives on Financial web address: <research.stlouisfed.org/publications/review>. Development and Economic Growth Single-copy subscriptions are also available free of charge. Send requests to: Federal Reserve Bank of St. Louis, Public Affairs Department, P.O. Peter L. Rousseau Box 442, St. Louis, MO 63166-0442, or call (314) 444-8808 or 8809. 107 Commentary The views expressed are those of the individual authors and do not necessarily reflect official positions of the Federal Reserve Bank of Eugene N. White St. Louis, the Federal Reserve System, or the Board of Governors. © 2003, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in their entirety if this copyright notice is included. 111 The Real Effects of U.S. Banking Please send a copy of any reprinted, published, or displayed materials Deregulation to George Fortier, Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166-0442; [email protected]. Philip E. Strahan Please note: Abstracts, synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank 129 Commentary of St. Louis. Please contact the Research Division at the above address to request permission. David C. Wheelock JULY/AUGUST 2003 i R EVIEW 135 Life-Cycle Dynamics in Industrial Sectors: The Role of Banking Market Structure Nicola Cetorelli 149 Commentary Raghuram G. Rajan ii JULY/AUGUST 2003 FEDERAL RESERVE BANK OF ST.LOUIS Christian T. Lundblad Contributing Authors Finance Department Kelley School of Business Indiana University Franklin Allen 1309 East Tenth Street Nippon Life Professor of Finance and Economics University of Pennsylvania Bloomington, IN 47405-1701 2253 Steinberg Hall–Dietrich Hall [email protected] 3620 Locust Walk, Suite 2300 Raghuram G. Rajan Philadelphia, PA 19104-6367 Joseph L. Gidwitz Professor of Finance [email protected] Graduate School of Business Geert Bekaert University of Chicago L. Cooperman Professor of Finance and 1101 East 58th Street Economics Chicago, IL 60637 Columbia Business School [email protected] Uris Hall 802 3022 Broadway Peter L. Rousseau New York, NY 10027 Economics Department [email protected] Vanderbilt University Box 1819 Station B Valerie R. Bencivenga Nashville, TN 37235 University of Texas at Austin [email protected] 1 University Station C3100 Austin, TX 78712 Philip E. Strahan [email protected] Finance Department Boston College Nicola Cetorelli 324b Fulton Hall Research Department 140 Commonwealth Avenue Federal Reserve Bank of Chicago Chestnut Hill, MA 02467 230 South LaSalle Street [email protected] Chicago, IL 60604-1413 [email protected] David C. Wheelock Research Department Campbell R. Harvey Federal Reserve Bank of St. Louis Fuqua School of Business 411 Locust Street Duke University St. Louis, MO 63102 Durham, NC 27708-0120 [email protected] [email protected] Eugene N. White Peter Blair Henry Graduate School of Business Economics Department Stanford University Rutgers University Stanford, CA 94305-5015 New Brunswick, NJ 08901-1248 [email protected] [email protected] Ross Levine Luigi Zingales Curtis L. Carlson Chair in Finance Robert C. McCormack Professor of Carlson School of Management Entrepreneurship and Finance University of Minnesota Graduate School of Business CSOM: 3-257 University of Chicago 321 19th Avenue South 1101 East 58th Street Minneapolis, MN 55455 Chicago, IL 60637 [email protected] [email protected] JULY/AUGUST 2003 1 R EVIEW 2 JULY/AUGUST 2003 Editor’s Introduction R. Alton Gilbert he Twenty-Seventh Economic Policy the use of banking services influences economic Conference, held November 7 and 8, 2002, growth. Their results suggest that monetary policy T focused on research that examines the influ- can exert an important influence on both the ence of financial markets and institutions on real development of national financial systems and real economic activity. While some economists trace economic development. this literature back to Schumpeter (1949, first Franklin Allen, as discussant of the Smith- published in 1912), Gurley and Shaw (1955), and Bencivenga article, raises a series of questions about Goldsmith (1969), published research on this topic the influence of monetary policy on the development has grown rapidly in recent years. This conference of financial systems and economic growth under volume is designed to examine various facets of alternative assumptions about their theoretical this literature through six articles by authors who model. In addition, Allen asks for empirical evidence have published their research on finance and real that monetary policy influences the development economic activity, as well as through the comments of financial systems. He notes that they cite the of their discussants. rapid development of financial systems in various THEORETICAL FOUNDATION South American nations in the 1980s and 1990s after these nations achieved substantial reductions Most of the recent research on the influence of in inflation rates. Allen asks whether there is evi- finance on real economic activity is empirical. Major dence to separate the influence of transactions costs challenges for contributors to this empirical literature on the development of financial systems from the include measuring the development of financial influence of monetary policy. systems and devising statistical tests that imply causality running from the development of financial DEVELOPMENT OF FINANCIAL systems to real economic activity, rather than the SYSTEMS AND ECONOMIC GROWTH development of financial systems in response to growth in real economic activity. Another strand of Ross Levine surveys the empirical literature on the literature on finance and real economic activity, the development of national financial systems and however, examines the theoretical foundation for economic growth. He focuses on studies that use an influence of financial markets and institutions three methods: first, cross-country regressions in on real economic activity. Bruce Smith was a major which the dependent variable is a measure of long- contributor to this theoretical literature. In fall 2001, run economic growth in each nation in the study Bruce agreed to write a theoretical paper for the and the independent variables include a measure conference, jointly with his wife and co-author, of the development of the financial system in each Valerie Bencivenga. Bruce died in the summer of nation; second, panel studies that combine cross- 2002, but Valerie presented the paper at the con- section and time-series data on measures of develop- ference and edited the paper for this conference ment in financial systems and measures of economic volume. growth; and third, micro studies of the association Theirs is the first article in this conference vol- between access to funds and growth at the industry ume. In the article, they develop a theoretical model or firm level. Levine notes that these studies lead to in which monetary policy affects the incentives of three conclusions: individuals to use banking services. In their model, 1. Countries with better-developed financial R. Alton Gilbert is a vice president and banking advisor at the Federal systems tend to grow faster. Reserve Bank of St. Louis. 2. This association does not appear to reflect © 2003, The Federal Reserve Bank of St. Louis. simultaneity between finance and growth.