Trade-Off Between Growth and Stability
There are two popular views on the effects of financial deepening. The first proposes a positive and causal relationship between the growth of the financial market of a country and the growth of its economy. The association is because of venture capitalists who support innovative projects that are risky but long-lasting, with high returns. On the other hand, the more integrated the financial market of a country is, the higher the probability of its economy experiencing macroeconomic risks. This is because of the increased volatility in economic growth that arises. Popov and Smet (2011) argue that these two views are valid depending on the level of the financial market, and thus the financial market aggravates the trade-off between growth and stability.
The financial sector is a significant contributor to the economic growth or decline of the economy of a country. The financial markets, in particular, enable those with excess funds to channel them towards projects that show potential for growth and returns, while screening out projects that are not feasible and monitoring projects to ensure that they are using the funds in the stipulated. In this way, financial markets improve the economic performance of a country. However, for the economic growth of an economy to be significant, the financial market has to be reasonably large (Loayza et al., 2017). However, as the financial depth increases, there is a reversal of the relationship and an increased threat of higher economic volatility concerning economic growth.
I do agree with the existence of a trade-off between economic growth and risk concerning the financial markets. This is mainly because of the 2008 global crisis that affected countries whose financial markets were large and complex. Therefore, I concur with Popov and Smet (2011) that the effects of financial development on economic growth decline at higher levels of development due to macroeconomic volatility. Any step by the government to regulate the stability of an economy will thus hamper economic growth (Xiu, 2018).