The macroeconomic consequences of financialisation
Creators: name: Khatatbeh, Ibrahim
Publisher: name: RMIT University
Year: 2024
Subjects: classificationCode: 350202
subject: Finance

description: Finance is considered as "the lifeblood of the economy" and it is integral to a country's economic growth and stability. However, this perception has been called into question, particularly following the global financial crisis, giving rise to new research questions. For example, does too much finance harm economic growth? And does the financial sector serve society's economic and social needs?<br><br>This thesis aims to provide cross-sectional and time-series evidence on the macroeconomic consequences of financialisation in an international context. Financialisation is defined as the increase in the size and importance of a country's financial sector relative to the overall economy. The primary objective of this research is to examine the robustness of the relationship between financialisation, on the one hand, and economic growth and income inequality, on the other. The technique of extreme bounds analysis (EBA)-proposed by Leamer (1983, 1985) and its modified variant suggested by Sala-i-Martin (1997)-is used to address the model uncertainty problem inherent in econometric analysis. EBA is extended to examine the robustness of other potential determinants of economic growth and income inequality. Another main objective is to investigate potential nonlinearity in the relationship between financialisation, economic growth and income inequality, which amounts to finding out if the financial Kuznets curve exists. <br><br>The initial analysis, based on Leamer's EBA, reveals that "nothing is robust" of the determinants of economic growth and income inequality. The analysis proceeds by using the Sala-i-Martin EBA, producing results suggesting that the effects of financialisation on economic growth are not robust with respect to changes in model specification (the choice of explanatory variables). However, the results reveal that trade openness, unemployment, economic freedom, school years, the agriculture sector share of GDP, the manufacturing sector share of GDP, population growth, urban population growth, government size, and labour force are robust determinants of economic growth. Moreover, the results of Sala-i-Martin EBA for income inequality suggest that financialisation is a leading driver of income inequality and that the effects are larger when transmitted through financial markets channels. The positive sign of the coefficients on the financialisation variables is in line with the inequality widening hypothesis and the recent evidence found in the financialisation literature. Furthermore, higher levels of financialisation boost the top 10% income share, which is consistent with the famous findings of Piketty (2014). In addition, the results show that law and order, labour union density, population, globalization, remittances, education, and agriculture sector share are considered as robust determinants of income inequality.<br><br>Supporting evidence is found for nonlinearity in the relationships between financialisation, economic growth and income inequality-based on annual data for 20 developed and developing countries-which may suggest the existence of the financial Kuznets curve (FKC). The FKC is represented by an inverted U-shaped curve for the finance-growth and finance-inequality relationships. The growth and inequality FKCs are estimated using the Phillips and Hansen (1990) fully modified ordinary least square (FMOLS) and the unobserved components model (UCM) developed by Andrew Harvey (1989). The empirical results lend support to previous findings of the growth-FKC nexus in all countries except for Mexico and Turkey. The results of estimating the inequality version of the financial Kuznets curve provide support for the existence of a U-shaped curve as well as an inverted U-shaped curve in more than half of the sample countries. The estimated turning points of the growth and inequality financial Kuznets curves fall in the range 100% to 130%, depending on the measure of financialisation used. Overall, the findings of this research demonstrate that excessive growth of the financial sector can become a drag on the real economy.