Abstract
After five decades of rapid expansion of microfinance worldwide, little is known about its aggregate effects and whether the "microfinance promise" of poverty reduction holds at the macro level. Challenging questions have arisen.
Here we explore the dynamic response of microfinance on economic growth, financial deepening and income inequality. Countries are grouped into three broad clusters (stable, moderate and poor) based on macro-institutional variables.
Our results show that microfinance has a significant long-term ability to affect the broader economy. However, the impact and dynamics of microfinance differ substantially across macro-institutional environments.
It grows in weaker environments, reaches its peak in developing economies, and then gradually "dies out" in more stable economies. While there is evidence of a positive impact of microfinance at the aggregate level, the response is different depending on whether countries are poor, moderately developed or economically stable.
Once countries climb up the macro-institutional "ladder," microfinance can take a different shape and its relationship with other macroeconomic fundamentals can change. Our results indicate that microfinance has the strongest effect when the external environment is supportive and proactive, in weak environments, microfinance cannot grow sufficiently.
Therefore, more attention should be given to supporting the socioeconomic dimensions of economies.