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Conclusions
The authors analysed the extent to which macro-economic policy over the business cycle in combination with financial sector characteristics can affect industry growth, focusing on fiscal and monetary policy, on the one hand, and on bank capital ratios and the cyclicality of credit, on the other. Following the Rajan and Zingales (1998) methodology, they interacted these policy measures at the country level with industry-level financial and liquidity constraints (measured by asset tangibility and the ratio of labour costs to sales in US industries) to assess the impact of this interaction on output growth at the industry level. They derived four main results.
First, a more countercyclical macro-economic policy (fiscal or monetary) significantly enhances output growth in more financially/liquidity-constrained industries, that is, in industries whose US counterparts display lower asset tangibility or a larger ratio of labour costs to sales.
Second, a higher bank capital to asset ratio tends to raise growth disproportionately more in industries with higher asset tangibility (and therefore disproportionally less in industries with lower asset tangibility).
Third, more countercyclical credit to non-financial firms tends to raise growth disproportionately in industries with larger labour costs to sales ratios.
Fourth and last, a higher bank capital to asset ratio tends to reduce the effect of monetary policy countercyclicality.
This new approach to the study of growth versus macro-economic policy and financial sector characteristics suggests at least two avenues for future research.
First, the evidence on the effect of countercyclical macro-economic policy on growth calls for going beyond the debate between supply side and demand side economists. While demand considerations can affect the market size for potential innovations, effects are fundamentally supply side-driven, as they operate through their influence on innovation incentives.
Second, the evidence produced in this paper on the effects of bank capital and the cyclicality of credit to non-financial firms on growth suggests non-trivial trade-offs for regulatory policy: in particular, higher capital adequacy ratios, insofar as they become binding, can be helpful in reducing systemic risk. However, they may also adversely affect industries with the lowest asset tangibility, which the authors typically think of as being the main engines for growth in developed economies. This, in turn, opens up the issue of how to optimally design financial regulations together with fiscal/monetary policy so as to reconcile financial stability and growth.