Credit Deepening: Precursor to Growth or Crisis?

Abstract

There are two areas of economic research that are closely related but have until recently developed independently. The first is the literature on the finance growth nexus that has shown how countries with greater financial depth grow more rapidly. The second is the literature on credit and financial crises that has shown that financial crises and recessions are usually preceded by rapid expansion of credit. Thus, credit deepening and credit booms are sometimes beneficial and sometimes not. In the last few years, there have been efforts to reconcile the two literatures. This paper reviews the two literatures and describes recent efforts to reconcile the two relationships. Much more work is required but it is important for policy makers to be able to distinguish good, growth enhancing credit booms from bad, crisis inducing ones.