Financial Development, Growth, and Crisis: Is There a Trade-Off?

43 Pages Posted: 12 Apr 2018

See all articles by Norman Loayza

Norman Loayza

World Bank - Research Department

Amine Ouazad

HEC Montréal

Romain Rancière

University of Southern California

Multiple version iconThere are 2 versions of this paper

Date Written: April 2018

Abstract

This paper reviews the evolving literature that links financial development, financial crises, and economic growth in the past 20 years. The initial disconnect—with one literature focusing on the effect of financial deepening on long-run growth and another studying its impact on volatility and crisis—has given way to a more nuanced approach that analyzes the two phenomena in an integrated framework. The main finding of this literature is that financial deepening leads to a trade-off between higher economic growth and higher crisis risk; and its main conclusion is that, for at least middle-income countries, the positive growth effects outweigh the negative crisis risk impact. This balanced view has been revisited recently for advanced economies, where an emerging and controversial literature supports the notion of "too much finance," suggesting that there might be a threshold beyond which financial depth becomes detrimental for economic growth by crowding out other productive activities and misallocating resources. Nevertheless, the growth/crisis trade-off is alive and strong for a large share of the world economy. Recognizing the intrinsic trade-offs of financial development can provide a useful framework to design policies targeting financial deepening, diversity, and inclusion. In particular, acknowledging the trade-offs can highlight the need for complementary policies to mitigate the risks, from financial macroprudential policies to monetary policy frameworks that monitor the growth of credit and asset prices.

Suggested Citation

Loayza, Norman and Ouazad, Amine and Rancière, Romain, Financial Development, Growth, and Crisis: Is There a Trade-Off? (April 2018). NBER Working Paper No. w24474. Available at SSRN: https://ssrn.com/abstract=3158913

Norman Loayza (Contact Author)

World Bank - Research Department ( email )

1818 H Street, N.W.
Washington, DC 20433
United States

Amine Ouazad

HEC Montréal ( email )

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7
Canada

Romain Rancière

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
12
Abstract Views
158
PlumX Metrics