Why Does Financial Sector Growth Crowd Out Real Economic Growth?

31 Pages Posted: 13 Feb 2015

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

Brandeis International Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Enisse Kharroubi

Bank for International Settlements (BIS)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2015

Abstract

In this paper we examine the negative relationship between the rate of growth of the financial sector and the rate of growth of total factor productivity. We begin by showing that by disproportionately benefiting high collateral/low productivity projects, an exogenous increase in finance reduces total factor productivity growth. Then, in a model with skilled workers and endogenous financial sector growth, we establish the possibility of multiple equilibria. In the equilibrium where skilled labour works in finance, the financial sector grows more quickly at the expense of the real economy. We go on to show that consistent with this theory, financial growth disproportionately harms financially dependent and R&D-intensive industries.

Keywords: growth, financial development, credit booms, R&D intensity, financial dependence

JEL Classification: D92, E22, E44, O4

Suggested Citation

Cecchetti, Stephen G. and Kharroubi, Enisse, Why Does Financial Sector Growth Crowd Out Real Economic Growth? (February 2015). BIS Working Paper No. 490. Available at SSRN: https://ssrn.com/abstract=2564267

Stephen G. Cecchetti (Contact Author)

Brandeis International Business School ( email )

415 South Street
Waltham, MA 02453
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
212-720-8629 (Phone)
212-720-2630 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Enisse Kharroubi

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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