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Impact of Micro Financial reforms vs Impact of Macro Financial reforms

Summary:
Spyridon Boikos, Ioannis Bournakis, Dimitris Christopoulos and Peter McAdam in this working paper differentiate between micro and macro financial reforms: We develop a horizontal R&D growth model that allows us to investigate the different channels through which financial reforms affect R&D investment and patent activity. First, a “micro” reform that abolishes barriers to entry in the banking sector produces a straightforward result: a decrease in lending rates which stimulates R&D investment and economic growth. Second, a “macro” reform that removes restrictions on banks’ reserves and credit controls. While this reform increases liquidity, it also increases the risk of default, potentially raising the cost of borrowing. This we dub the “reserves paradox” – this makes banks offset

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Spyridon Boikos, Ioannis Bournakis, Dimitris Christopoulos and Peter McAdam in this working paper differentiate between micro and macro financial reforms:

We develop a horizontal R&D growth model that allows us to investigate the different channels through which financial reforms affect R&D investment and patent activity.

First, a “micro” reform that abolishes barriers to entry in the banking sector produces a straightforward result: a decrease in lending rates which stimulates R&D investment and economic growth.

Second, a “macro” reform that removes restrictions on banks’ reserves and credit controls. While this reform increases liquidity, it also increases the risk of default, potentially raising the cost of borrowing. This we dub the “reserves paradox” – this makes banks offset the rise in the default rate with a higher spread between loans and deposit rates.

Thus our model suggests that whilst micro reforms boost innovation, macro reforms may appear negative. We test and find empirical support for these propositions using a sample of 21 OECD countries.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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