A paradigm is presented where both the extent of financial intermediation and the rate of economic growth are endogenously determined. Financial intermediation promotes growth because it allows a higher rate of return to be earned on capital, and growth in turn provides the means to implement costly financial structures. Thus, financial intermediation and economic growth are inextricably linked in accord with the Goldsmith-McKinnon-Shaw view on economic development. The model also generates a development cycle reminiscent of the Kuznets hypothesis. In particular, in the transition from a primitive slow-growing economy to a developed fast-growing one, a nation passes through a stage where the distribution of wealth across the rich and poor widens.
A two country overlapping generations model is constructed, in which financial intermediation arises endogenously as an incentive compatible means of economizing on monitoring costs. Because of international credit markets. The model is used to generate the existence of transaction costs, money markets in the two countries are segmented and investors have differential access to predictions concerning the role of international intermediation in economic development, and to examine the nature of business cycle phenomena across alternative exchange rate regimes. Disturbances are propagated by a credit allocation mechanism, which also lends a novel flavor to the model's long run properties.
How much technological progress has there been in structures? An attempt is made to measure this using panel data on the age and rents for buildings. This data is interpreted through the eyes of a vintage capital model where buildings are replaced at some chosen periodicity. There appears to have been significant technological advance in structures that accounts for a major part of economic growth.