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Tue dole of National Bank of Rwanda from 1995 to 2010

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par Paterne RUKUNDO
National university of Rwanda - A0 2011

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2.6. Financial development

The costs of acquiring information, enforcing contracts, and making transactions create incentives for the emergence of particular types of financial contracts, markets and intermediaries. Different types and combinations of information, enforcement, and transaction costs in conjunction with different legal, regulatory, and tax systems have motivated distinct financial contracts, markets, and intermediaries across countries and throughout history. In arising to ameliorate market frictions, financial systems naturally influence the allocation of resources across space and time. (Merton and Bodie, 1995: 12)

To organize a discussion of how financial systems influence savings and investment decisions and hence economic growth, Levine (1996) focus on five functions provided by the financial system. In easing information, enforcement, and transaction costs, financial systems provide five broad categories of services to the economy. While there are other ways to classify the functions of the financial system, we believe that the following five categories are helpful in organizing a review of the theoretical literature and tying this literature to the history of economic thought on finance and growth. In particular, financial systems:

- Produce information ex ante about possible investments and allocate capital;

-Monitor investments and exert corporate governance after providing finance;

-Facilitate the trading, diversification and management of risk;

-Mobilize and pull savings;

-Ease the exchange of goods and services.

While all financial systems provide these financial functions, there are large differences in how well financial systems provide these functions. Financial development occurs when financial instruments, markets, and intermediaries ameliorate- though do not necessarily eliminate-the effects of information, enforcement, and transactions costs. Thus, the financial development involves improvements in the above-mentioned functions.

2.7. Financial development and Economic growth

Nobel Prize Laureates and other influential economists disagree sharply about the role of the financial sector in economic growth. Finance is not even discussed in a collection of essays by the «pioneers of development economics», which includes three winners of the Nobel Prize (Meier and Seers, 1984). Nobel Laureate Robert Lucas (1988) dismisses finance as a major determinant of economic growth calling its role «over-stressed».

Joan Ribinson (1952, p. 86) famously argued that» where enterprise leads finance follows«. From this perspective, finance does not cause growth; finance responds automatically to changing demands from the «real sector».

At the other extreme, Nobel Laureate Merton Miller (1988: 14) argues that, the idea that financial markets contribute to economic growth, is a proposition too obvious for serious discussion. Similarly, Schumpeter (1912), Gurley and Shaw (1955) and McKinnon (1973) have all rejected the idea that the finance-growth nexus can be safely ignored without substantially impending our understanding of economic growth.

Resolving the debate and advancing our understanding about the role of financial sectors in economic growth has helped to distinguish among competing theories of the process of economic growth.

Furthermore, information on the importance of finance in the growth process has affected the intensity with which researchers study the determinants, consequences and evolution of financial systems. Finally, a better understanding of the finance-growth nexus may influence public policy choices since legal, regulatory, tax and macroeconomic policies all shape the operation of financial systems.

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