Financial Deepening in a Two-Sector Endogenous Growth Model with Productivity Heterogeneity

This paper studies the effects of financial deepening and public spending on human capital formation, working hours and growth in a model with financial frictions and productivity heterogeneity. The paper first shows that in the range of capital tax rates that attains a balanced growth path, taxation exerts inverted U-shaped effects on growth. The paper then analytically derives and shows that the growth maximizing tax rate and the corresponding growth are increasing concave functions of the financial deepening level. Finally, it is shown that theoretical predictions of the model are in line with data from OECD countries