Financial intermediation and economic growth in less‐developed countries: A theoretical approach

In stressing the importance of financial intermediation in the development of the LDCs, neither the approach of financial deepening nor that of real interest rates has clarified the relationship between financial intermediation and real development. This paper shows—within a two‐sector model, but extendable to the n‐sector case—that high (equilibrium) real interest rates are growth‐promoting, even if total real savings is interest insensitive (a controversial empirical question), because they bring about an improvement in the quality of the capital stock in a well‐defined sense. The analysis also has implications for the theories of inflation and income distribution in the LDCs. Notes The author would particularly like to thank Prof. John Williamson, Warwick University (England) and Messrs. Deena R. Khatkhate and Delano P. Villanueva for their helpful suggestions on an earlier draft of this paper. However, they are absolved of any responsibility for remaining errors. The views expressed here do not necessarily represent those of the International Monetary Fund.