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The Financial System and Economic Performance

  • Chapter
International Competitiveness in Financial Services

Abstract

The core function of the financial system is to facilitate the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment. This system includes the basic payment system through which virtually all transactions clear and the capital markets which include the money, fixed-income, equity, futures, and options markets and financial intermediaries. The capital markets are the medium that makes possible the basic cash-flow cycle of household savings flowing to capital investments by firms, followed by a return to households (via profits and interest payments) for consumption and recycling as new savings. Through often-elaborate financial securities and intermediaries, the capital markets provide risk-pooling and risk-sharing opportunities for both households and business firms. Well-developed capital markets allow for separation of the responsibility for the capital-flow requirements of investments from the risk-bearing responsibility for those investments. In both an international and domestic context, this facility permits efficient specialization in production activities, according to the principle of comparative advantage. In addition to these manifest functions, the capital market serves an important, perhaps more latent, function as a key source of information that helps coordinate decentralized decision-making in various sectors of the international economy. Interest rates and security prices are used by households or their agents in making their consumption-saving decisions and in choosing the portfolio allocations of their wealth. These same prices provide critical signals to managers of firms in their selection of investment projects and financings.

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  1. Graduate School of Business Administration, Harvard University, Dillon 32, Soldiers Fields, Boston, MA, 02163, USA

    Robert C. Merton (George Fisher Baker Professor of Business Administration)

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  1. Robert C. Merton
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Marvin H. Kosters Allan H. Meltzer

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Merton, R.C. (1990). The Financial System and Economic Performance. In: Kosters, M.H., Meltzer, A.H. (eds) International Competitiveness in Financial Services. Springer, Dordrecht. https://doi.org/10.1007/978-94-011-3876-5_2

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