Financial Deepening, Credit Crises, Human Capital and Growth

In spite of extensive research exploring the implications of financial matters for economic growth, a general equilibrium macroeconomic model of financial frictions with human capital as an engine of growth is lacking in the literature. This paper helps to fill this gap, proposing a model that includes endogenous growth, human capital, and financial constraints. We derive short-term and long-term predictions from the model. From a long run perspective, we explore the relationship between financial depth and growth, and predict that this relationship is non-monotonic. Higher financial depth is initially associated with higher growth, but at diminishing rates. Further increases in financial depth become growth detrimental. From a short-run perspective, we analyze the role of transitory financial disruptions in producing persistent economic changes, a phenomenon that arguably happened during the Great Recession and the years that followed. We propose an explanation for these persistent effects based on human capital.