Finance is a vital ingredient of economic growth, but there can be too much of it. Over the past 50 years, credit by banks and other institutions to households and businesses has grown three times as fast as economic activity. At these levels, further expansion is likely to slow long-term growth and raise inequality.
Finance and inclusive growth, Long paper
Press release: Financial sector must promote inclusive growth
The long-term costs from credit overexpansion fall disproportionately on the socially vulnerable.
The empirical work suggests three key mechanisms:
1. Financial sector workers are very concentrated at the top of the income distribution
2. High income earners can and do borrow more
3. The growth of stock market capitalisation has contributed to greater income inequality
The main channels linking the long-term increase in credit and slowing growth:
1. Excessive financial deregulation
2. A more pronounced increase in bank lending than bond financing
3. Too-big-to-fail guarantees by the public authorities
4. A lower quality of credit
5. A disproportionate increase in household credit compared with business credit
The policy response: A better architecture for the financial system
Ensuring that the financial sector contributes to strong and equitable growth involves avoiding credit overexpansion, which hurts growth and income equality, and improving the structure of finance:
1. Avoiding credit overexpansion
2. Improving the structure of finance
The main papers providing background to this note are:
Cournède, B. and O. Denk (2015), “Finance and Economic Growth in OECD and G20 Countries”, OECD Economics Department Working Papers, No. 1223, OECD Publishing, Paris.
Further reading: Investment and the B- global economy: How to get a better grade