Source 8 Cecchetti and Kharroubi (BIS 2015; NBER 2018)
Why Does Financial Sector/credit Growth Crowd out Real Economic
Growth?
Full references (APA + links)
• Cecchetti, S. G., & Kharroubi, E. (2015). What is the Real Economic
Growth Crowded out by Financial Sector Growth? BIS Working Paper No.
490. Bank of International Settlement.
[Link]
• Cecchetti, S. G., & Kharroubi, E. (2018). Why then Does Credit
Growth Crowd out Real Economic Growth? NBER Working Paper No. 25079.
National Bureau of Economic Research. 25079.
What this is:
Since it was done by two of the best institutions (BIS and NBER). They
pose a question: does rapid expansion of finance or credit nowadays have
on balance the real economy (productivity and product per worker) in the
future--why and why not?
Type & credibility:
Research in reputable organizations of high quality and is highly utilized in
both academic and policy literature.
Where to find it:
BIS paper page (".free PDF) and NBER working paper page (PDF).
Central question:
In rapid credit booms or financial industries does swift growth cause
reduced future productivity and the declining output per employee? In
case yes, what are the channels?
What they did:
• Constructed nation panels (a range of developed economies in a
number of decades).
• The size of /growth of financial sector (measured) and credit growth
and associated them with productivity (TFP) and output per worker.
• Added industry level tests and a simple economic mechanism to
visualize the movement of funds and talent through booms (e.g. out of
R&D intensive industries).
Key results:
• Rapid increase in finance/credit gains/smaller growth in real gains.
Alternatively, the countries with high levels of finance or credit growth are
high in terms of poorer productivity and reduced growth of output per
worker, later.
• Why (two channels):
1. Mal distribution of credit: Booms result in lending to easy pledging
projects that have high collateral (which can be less productive than
innovative uses).
2. Talent redistribution: The financial sector will be booming, absorbing
skilled labour in the financial sector rather than in industries that are
intensive in research and development, hence develop less closely.
• Its impact is higher in the sophisticated economies and even in
credit boom (not regular periods).
Quote:
The accelerated finance/credit development is likely to choke out the real
economy by redistributing resources that will otherwise go to the creative
sectors and taking the talent away.
The importance of this to my project:
Gives rule upper: There is a limit to the utility of the debt rule, and when
the credit is greatly extended then you will find it injuring the future
development.
• Sustains your Good-Debt Checklist:
o Raise awareness on credit growth (not just the level).
o Target productive uses (SMEs, machinery, skills) as opposed to asset
booms.
o Guardrail (LTV/DTI caps, counter-cyclical capital buffer, enhanced
credit information) to make credit useful.
Limits / cautions:
Results are average patterns; this is because the results are based on who
makes the borrowing (mortgages vs business), the cause, and institutions.
• The magnitude of the effect may vary according to country and
time.
Where it shall be cleared in your dossier.
• Banks / Risks - why credit booms are damaging to the growth ahead.
Lessons / Synthesis Add the rule, not too fast, not too much.
• Comparative to the country — why a country with such a fast credit
growth can slow down, whereas countries whose credit depth is shallow
but transitioning to moderate depths, still have the opportunity to become
deeper.
Summary:
In these articles, the financial sector or credit is found to experience
extremely high growth and hence when this occurs, the countries tend to
experience slower productivity and weaker output per worker a few years
later. The reason is twofold. First, misallocation: when the boom occurs,
banks favor loans that are simple to obtain and simple to secure against
(such as real estate), in favor of risky but more profitable, innovative
loans. Second, the reallocation of talent: a thriving finance industry takes
potential talent needed in other sectors (such as those with heavy R&D)
and thus the facilities innovate less. Based on decades of data about 20
leading economies and industry-level checks, the authors obtain the
conclusion that such effects are the most effective in developed countries
and credit boom periods. It is not that it is bad to finance. It is because the
growth of money that has been accelerated may be damaging to the
actual economy in future. To policy you look at the rate at which credit is
growing, have lending be productive, apply guardrails (such as LTV/DTI
ratio and counter-cyclical capital buffers) to keep debt beneficial rather
than the cause of future slowdowns.