Friday, March 25, 2011

Too much finance?

This paper examines whether there is a threshold above which financial development no longer has a positive effect on economic growth. We develop a simple model in which the expectation of a bailout may lead to a financial sector which is too large with respect to the social optimum. We then use different empirical approaches to show that there can indeed be “too much” finance. In particular, our results suggest that finance starts having a negative effect on output growth when credit to the private sector reaches 110 percent of GDP. We conclude by showing that the size of the financial sector was a significant amplifying factor in the global crisis that followed the collapse of Lehman Brothers in September 2008.

The vox.eu article about it is here

The paper is here

An older version of the paper is  here

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37 comments:

Anonymous said...

NIce paper. However: why all this theory. After all, your regressions just estimate some possible relationships between empirical variables which, when push comes to play, are rather distinct from your theoreticval ones. This distracts from your scientific results, ic. the estimates. eitehr redefine the theoretical variables in such a way that they are consistent, in definition and concept, to your empirical ones or leave them out.

Ugo said...
This comment has been removed by the author.
Ugo said...

thanks!

Ugo

Panicos Demetriades said...

Certainly a very interesting paper. I have found similar results to Rioja and Valev in my paper with Siong Hook Law entitled "Finance, institutions and economic development" IJFE 2006.

Moreover, much of my work in the 1990s showed that the link between finance and growth was not robust, and even where present frequently reflected reverse causality. See, for example my paper with Khaled Hussein JDE (1996) and with Arestis in Economic Journal (1997). Also, my paper in JMCB 2001 with Arestis and Luintel shows that the relationship between finance and growth is altogether absent or weak in the UK and the US.

I have more comments on your paper but have to rush off to a meeting. Email me for more.

Panicos Demetriades
pd28@le.ac.uk

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