Is Too Much Liquidity Harmful to Economic Growth?

Abstract

This paper provides evidence on the relationship between financial liquidity and economic growth. Using a panel data of 136 countries, we find that there exists a threshold above which the marginal effect of financial liquidity on economic growth becomes negative. In particular, the turning points for which domestic credit to private sector and stock market turnover start having negative effect on growth are 104% GDP and 105% respectively. Our results are robust to country income level groups, alternative model specifications, proxies for financial liquidity, and are not driven by macroeconomic volatility, banking crises, stock market crashes.

Keywords: financial liquidity, economic growth, non-linearity

JEL Classification: E44, G2, O1