1. Comments on: Financial Development, Financial Fragility, and Growth by Norman Loayza and Romain Ranciere Graciela L. Kaminsky George Washington University Second Workshop of the Latin American Finance Network Cartagena, Colombia December 3, 2004

2. Motivation Financial development triggers growth: –The endogenous growth literature claims this link. For example, Ross Levine (2004) reports that increasing financial deepening from the mean of the lowest quartile to the mean of the upper quartile (of the distribution of domestic credit/GDP) increases growth by 1 percentage point. –Bekaert, Campbell and Lundblad ( 2001) results indicate that liberalization promotes growth, with growth rates increasing 1 percentage point following liberalization. Financial liberalization harms growth –The international finance literature suggests that financial liberalization triggers “excesses” with booms and busts in financial markets and a collapse in economic activity. –Kaminsky and Reinhart (1999) results indicate that the probabilities of a banking crisis increase by 40 percent following financial liberalization. See also, Detragiache and Demirguc-Kunt (1999). These opposite results have coexisted without any explanation.

3. Goals of the Paper This paper tries to explain the apparently contradictory results of the literature. In particular, the authors try to untangle the short-run and long-run effects of financial deepening on output growth. Short-run pain, long-run gain? Possible explanations.

4. The Estimations y = GDP per capita growth rate X = control variables including: financial depth initial level of GDP government consumption/GDP volume of trade/GDP inflation rate.

5. The Data Between 66 and 82 developing and developed countries, depending on data availability. Sample: 1960-2000.

6. The Results The Long Run: A 1 percent increase in the ratio of private credit to GDP leads to a rise of 0.7 percentage points in the growth rate of per capital GDP. The Short Run: The average response of the growth rate to an increase in the growth rate of private credit/GDP is -6. Interpretation: Boom-bust cycles in credit lead to a temporary output collapse, still permanent financial deepening promotes growth.

7. The Short-Run Can the short-run adverse effect of credit on growth be explained by: –Banking crises? (number of years of systemic banking crises in the 1960-2000 period) –Financial volatility? (standard deviation of the growth rate of the private credit to GDP ratio over the period 1960-2000). Yes

8. More Results Typical growth equations with a pooled (cross-country, time-series) data set. Eighty two countries. For each country, 8 non-overlapping five-year periods over 1960-2000. Financial deepening has a positive effect on growth but … Banking crises and financial volatility harm growth.

9. Supporting Evidence on: Short- Run Pain, Long-Run Gain Source: “Short-Run Pain, Long-Run Gain: The Effects of Financial Liberalization” Graciela Kaminsky and Sergio Schmukler, NBER Working Paper 9787, June 2003.

12. Comments Findings from the stock market responses to liberalization and the stories that the authors tell in the theoretical section of the paper suggest that: –Threshold levels may matter in the relationship between financial development and growth. Booms in credit may not trigger collapses in economic activity in mature financial markets. –Do institutions matter when examining the short-run effect of financial development? Perhaps interaction terms? Also, is there a linear relationship between financial deepening and growth? Isn’t = 0.7 too big? Does financial depth affect the steady state growth rate?

13. More Comments In the long run, financial depth fuels growth but in the short run it harms growth. What are the channels? –Do short-run booms hurt capital accumulation? or productivity? –Similarly, for the long-run relationship: Is it capital accumulation or productivity? Financial development goes hand in hand with financial liberalization (and integration with world capital markets). But here Norman and Romain just look at domestic financing not world financing. Physical location may not matter as much with financial globalization. Bias??? Report in a graph the short-run responses by country (organized by size) with the country names.

14. Last and Very Important Comment Kaminsky in the abstract of the paper should be written with a final Y not i.

15. Conclusions Very interesting paper, a must-read. Very careful estimations. The first paper to look jointly at the short- and long-run effects of financial deepening on growth. I like that section very much. The authors should expand this part of the paper.