Does Too Much Finance Harm Economic Growth?

Abstract

a b s t r a c tThis study provides new evidence on the relationship between finance and economic growth using an innovative dynamic panel threshold technique. The sample consists of 87 developed and developing countries. The empirical results indicate that there is a threshold effect in the finance-growth relationship. In particular, we find that the level of financial development is beneficial to growth only up to a certain threshold; beyond the threshold level further development of finance tends to adversely affect growth. These findings reveal that more finance is not necessarily good for economic growth and highlight that an ''optimal'' level of financial development is more crucial in facilitating growth.

Is the Relationship Between Financial Development and Economic Growth Monotonic? Evidence from a Sample of Middle-Income Countries

“…This resonates with the argument put forward, among others, by Cetorelli and Peretto (2012). They point out that the relationship between financial development and accumulation of physical capital is ambiguous: more bank competition translates into more credit availability for firms, but at the same time banks provide fewer additional services to the firms, resulting in greater probability of the investment failing (see also Bezemer et al, 2014;and Law and Singh, 2014). Further research should shed more light on this, including the factors that underlie the relationship between financial development and economic growth (or investment).…”

“…Rousseau and Wachtel (2002) identify the inflation channel as providing the link between financial development and growth, and find that growth is not affected when annual inflation exceeds 13%. Law and Singh (2014) explore whether finance promotes economic growth after a country's financial development exceeds a certain threshold level. Using dynamic panel threshold methods, they consider a panel of 87 (developed and developing) countries over the 1980-2010 period, averaged over 5 years periods.…”

Financial–Real-Side Interactions in an Extended Monetary Circuit with Shadow Banking: Loving or Dangerous Hugs?

“…Second, several contributions even from a mainstream tradition describe finance as an expanding industry in modern developed economies accounting for an increasing share of their GDP (Cecchetti and Kharroubi, 2012;Beck et al, 2014;Law and Singh, 2014). In Figure 13, the boundaries of the financial sphere, traced by the grey dashed lines, are much wider than what is portrayed in Figure 12.…”

Financial Integration in East Asia: Past, Present and Possible Futures

“…As early as the 1980s, the three indexes have been clustered around the middle range, though exchange rate stability has been the most pervasive policy choice." (p. 26) 11 There is also evidence from cross-country regressions that the relationship between financial development and growth is non-monotonic, instead having the nature of an inverted U or V. See Law and Singh (2013) for an example of such evidence, and references to numerous other studies.…”