V32-13

Question

The causal relationship between economic growth and financial market development has been the subject of intensive theoretical and empirical studies. The question is whether financial market development produces economic growth or the arrow of causation points in the other direction.

The recent revival of interest in the link between financial development and growth stems mainly from the insights and techniques of internally originated growth models, which have shown that there can be self-sustaining growth without externally originated technical progress and that the growth rate can be related to preferences, technology, income distribution and institutional arrangements. This provides the theoretical underpinning that early contributors lacked: financial intermediation can be shown to have not only level effects but also growth effects.

Pagano suggests three ways in which, under the basic internally fueled growth model, the development of the financial sector might affect economic growth. First, it can increase the productivity of investments. Second, an efficient financial sector reduces transaction costs and thus increases the share of savings channeled into productive investments. (An efficient financial sector improves the liquidity of investments.) Third, financial sector development can either promote or reduce savings.

It can be inferred from the passage that the author believes which of the following about the belief that financial development leads to economic growth?

A. It is likely to be true, though it has not been definitively proven. 
B. It is more likely than the belief that economic growth leads to financial development. 
C. It is less supported by theoretical studies than by empirical studies. 
D. It is true in a number of limited situations. 
E. It is now accepted by most experts working on internally originated growth models.

souvik101990 · Answer

Official Solution:

The causal relationship between economic growth and financial market development has been the subject of intensive theoretical and empirical studies. The question is whether financial market development produces economic growth or the arrow of causation points in the other direction.

The recent revival of interest in the link between financial development and growth stems mainly from the insights and techniques of internally originated growth models, which have shown that there can be self-sustaining growth without externally originated technical progress and that the growth rate can be related to preferences, technology, income distribution and institutional arrangements. This provides the theoretical underpinning that early contributors lacked: financial intermediation can be shown to have not only level effects but also growth effects.

Pagano suggests three ways in which, under the basic internally fueled growth model, the development of the financial sector might affect economic growth. First, it can increase the productivity of investments. Second, an efficient financial sector reduces transaction costs and thus increases the share of savings channeled into productive investments. (An efficient financial sector improves the liquidity of investments.) Third, financial sector development can either promote or reduce savings.

It can be inferred from the passage that the author believes which of the following about the belief that financial development leads to economic growth?

A. It is likely to be true, though it has not been definitively proven. 
B. It is more likely than the belief that economic growth leads to financial development. 
C. It is less supported by theoretical studies than by empirical studies. 
D. It is true in a number of limited situations. 
E. It is now accepted by most experts working on internally originated growth models.

This is an Inference question, so we need to spot the option that Must Be True, and dump the 4 options that are either NOT true, or NOT necessarily true.

The key topic in the passage is the causal relationship between these two elements - financial development and economic growth. This is an inference question, so the author's belief will not be given directly.

(A) This is the correct choice. The author does present evidence to support the idea that financial development leads to economic growth, especially in the list of reasons given by Pagano. However, though the author does say that the theory has renewed support through "growth models," the author does not clearly present a personal opinion on the strength of the theory. Therefore, the author does express the belief that there is a clear likelihood that the theory is true, but doesn't go further and completely endorse it.

(B) There is no comparison made between the two different "causal directions." They might both be true.

(C) If anything, the passage provides more theoretical than empirical (real-world) support.

(D) Though of course the author might believe this to be the case, we cannot infer it strictly from the passage.

(E) There is no mention of what the majority of these people believe.

Answer: A

tuan97 · Answer

The author references Pagano to outline three theoretical explanations that lend support to the hypothesis that "financial intermediation promotes economic growth". However, how does theorising about the hypothesis make it "more likely to be true"? There is no evidence that confirms the validity of any of these three explanations, so we cannot conclude that they are true or not, as well as if they likely to be true.

Moreover, the author doesn't express any personal thought; he only cites others' arguments without elaborating further on them. It therefore cannot be said that the author BELIEVES anything about the possible causal relationship being discussed.

Personally, I think that answer D should be the correct one. It narrows the scope of the relationship to within a specific circumstance, which in this case is the basic internally fueled growth model, under which the three explanations as Pagano presents applies to the hypothesis and suggest that the relationship is one of causation in which the former triggers the latter.

I hope you could review this question and respond to my comment. Thank you!

V32-13

Prep Toolkit

Top 5 GMAT Debrief Videos

615 to 715 in 15 Days (Ria's Strategies)

More than Quant/Verbal Abilities: Speed vs. Accuracy

745 with Only Self-Prep and GMAT Club

From 555 to 765: 210-point Improvement

Perfect 805 Score Debrief by Julia

My Rewards