DP17022 Too Much Finance... For Whom? The Causal Effects of the Two Faces of Financial Development

Author(s): Rachel Cho, Rodolphe Desbordes, Markus Eberhardt
Publication Date: February 2022
Keyword(s): Difference-in-difference, Economic Growth, financial crises, Financial Development, Heterogeneous Treatment Effects, Interactive Fixed Effects
JEL(s): F43, G01, G21, O40
Programme Areas: Financial Economics, Development Economics, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17022

We revisit the causal implications of financial deepening for economic development and banking crises adopting a heterogeneous difference-in-difference framework. Using a large panel dataset over the past six decades we demonstrate that very high levels of financial development, proxied by credit/GDP, are neither associated with lower economic growth in the long-run nor with a higher short-run propensity of triggering financial crises due to 'credit booms gone bust' cycles or unfettered capital inflows. We then investigate the 'too much finance' narrative at intermediate levels of financial development and, again, fail to detect any evidence for detrimental long-run growth effects. We further demonstrate that for this group of (emerging) economies elevated levels of financial development do not hamper a shift from capital accumulation to an innovation-based ('modern') growth paradigm, or their structural transformation away from the primary sector. There are however indications that 'too much finance' for this group can increase the propensity for banking crises through capital inflows and commodity price movements. Hence, our analysis can confirm elements of a 'too much finance' effect albeit (i) not for advanced economies at the top of the credit/GDP distribution but those at more intermediate levels, and (ii) even for these countries seemingly without any negative implications for their long-term growth trajectories.