Little evidence for ‘too much finance’

In the aftermath of the Global Crisis, the literature on finance and growth experienced a ‘paradigm shift’ whereby a pre-Crisi consensus of a strictly positive and linear relationship (e.g. Beck et al. 2000, Levine et al. 2000, Beck et al. 2004, Levine 2005) was replaced by a new consensus of a more complex, likely concave relationship: economies could experience ‘too much of a good thing’. The influential work by Arcand et al. (2015), among others, established the presence of such a non-linearity at the top of the financial development distribution (see related Vox columns by these authors here and Thorsten Beck here, here and here).

The ‘darker side’ of financial development (Loayza et al. 2018) can come about if increased deepening of advanced financial markets (a) furthers services with lower growth potential (e.g. household rather than firm credit); (b) leads to a misallocation of talent (e.g. a ‘brain drain’ to financial services); and/or (c) results in an increased vulnerability to financial crises. The latest is the subject of a large separate literature (Sufi and Taylor 2021) with a “near-consensus view” (Bordo and Meissner 2016: 31) that banking crises are “credit booms gone bust” (Schularick and Taylor 2012, summarised here), although capital flow bonanzas also feature prominently as crisis triggers (Reinhart and Rogoff 2013, Ghosh et al. 2014, Caballero 2016; see related Vox columns here and here).¹  

In a recent paper (Cho et al. 2022), we…