Money,finance and economic development; the case of India
Contemporary macro theory has taken a peculiar stand on the role of the institution of’ money and the financial system in the economic processes of’ a market economy. Though it has paid B great deal of attention to the functioning of the money and the financial markets and also its implications to the short run stabilization policies, it has divorced the problems of economic growth and development from the analysis of the problems of the monetary and financial development of a society. This is probably why the growth models are cast in physical terms and the growth path is shown to be neutral to the changes in the monetary and financial structure. Attempts are recently being made to generalize the theory of economic growth and development and overcome the drawbacks. Tobin and other economists have tried to accommodate real money balances in the neo-classical and Keynesian growth models. Gurley and Shaw and others have emphasized the importance of financial intermediaries in the saving investment process. This thesis integrates and expands the theoretical approaches developed by these economists and empirically tests them For the Indian economy by constructing a macro-econometric model with five equations and three identities. Three hypotheses have been proposed. The first hypothesis, based on the importance of money in clearing the ‘payments matrix’ of the society says that the absorption and use of the real balances by the economic actors saves productive resources of labor and capital that would be spent in effecting exchange in a barter world. Honey, in this sense, like labor and capital, has a marginal productivity which is positive and which decreases as the intensity of the use of money increases. The second hypothesis states that in the absence of a financial system, the savers, the surplus units, will invest bulk of their savings themselves and the professional investors who can perceive and explore productive investment opportunities will be starved of investable resources. The evolution of a financial system results in the separation of the functions of saving and investment and helps to channel the savings to the most productive investment opportunities. As a result, the productivity of the aggregate capital stock increases at the margin. The third hypothesis is that the provision of financial assets with varied risk-return-liquidity characteristics may load to e higher proportion of income saved in a developing economy. The macro econometric model, which highlights these relationships has been estimated by 2 stage least squares using 1951-71 data of the Indian economy. Real balances were introduced directly as a factor of production in the aggregate production function. A variable representing the efficiency of investment allocation was included in the Production Function. Financial development was represented by an index defined as the ratio of the change in the stock of financial assets in a year to the trend value of nominal Net National Product in that year. This index explained a part of the changes in the efficiency variable and savings. All the financial development variables were found to be statistically significant and increase the explanatory power of the equation to which they belonged. The structural model was solved for the reduced form and the reduced form coefficients were used to analyze the contribution made by monetary and financial development to the changes in the teal Net Domestic Product. Also the forecasting ability of the model was tested by partial as well as total analysis. It was found that next to labor and capital, financial development was the most important contributor to the changes in real income during the sample period. The marginal productivity of real balances was found to be as high as 2.043 and the income elasticity of the demand for real balances was .845. The money supply elasticity of the general price level was nearly unity. Also, a 1 per cent rate of interest paid on real balances increased their demand by Rs.46 cores and real income by ﬂs.146.35 cores. A one-point increase in the index of financial development led to a Rs.94 crores increase in real income mainly via e Rs.34.7 crores increase in the private Savings and 6 9-42 point increase in the efficiency of investment allocation. Inflationary expectations adversely affect private savings and the absorption of real balances and through them the real income. The major implications are: (i) Indiscriminate increases in the nominal money stock retard the pace of monetization and financial development and adversely affect savings. (ii) The best way to stimulate the absorption of real balances and other financial assets is to increase the real yield on them by rationalizing the structure of interest rates so that they reflect the true opportunity cost of savings in the society. In any case, high and highly variable rates of inflation reduce this yield and discourage the holding of r.al balances as well as fixed income yielding securities. (m) In underdeveloped countries, finding investable resources is more important than finding investment opportunities. So a reallocation of the resources of the financial system in favour of Savings mobilization would increase the productivity of these Resources and the effectiveness of the role of the financial system in economic development.
- Thesis and Dissertations