Reassessing The Impact Of Finance On Growth

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BIS Working Papers
No 381

Reassessing the impact of finance on growth by Stephen G Cecchetti and Enisse Kharroubi

Monetary and Economic Department
July 2012

JEL classification: D92, E22, E44, O4
Keywords: Growth, financial development, credit booms, R&D intensity, financial dependence

BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS.

This publication is available on the BIS website (

© Bank for International Settlements 2012. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated.

ISSN 1020-0959 (print)
ISSN 1682-7678 (online)

Reassessing the impact of finance on growth
Stephen G Cecchetti and Enisse Kharroubi*

July 2012

This paper investigates how financial development affects aggregate productivity growth.
Based on a sample of developed and emerging economies, we first show that the level of financial development is good only up to a point, after which it becomes a drag on growth.
Second, focusing on advanced economies, we show that a fast-growing financial sector is detrimental to aggregate productivity growth.

JEL classification: D92, E22, E44, O4
Keywords: Growth, dependence *

financial development,

credit booms, R&D intensity, financial

Cecchetti is Economic Adviser at the Bank for International Settlements (BIS) and Head of its Monetary and
Economic Department, and Kharroubi is Economist at the BIS. This paper was prepared for the Reserve Bank of India’s Second International Research Conference in Mumbai, India, on 1–2 February 2012. We thank
Claudio Borio, Leonardo Gambacorta, Christian Upper and Fabrizio Zampolli for helpful suggestions; and
Garry Tang for valuable research assistance. The views expressed in this paper are those of the authors and not necessarily those of the BIS.




One of the principal conclusions of modern economics is that finance is good for growth. The idea that an economy needs intermediation to match borrowers and lenders, channelling resources to their most efficient uses, is fundamental to our thinking. And, since the pioneering work of Goldsmith (1969), McKinnon (1973) and Shaw (1973), we have been able to point to evidence supporting the view that financial development is good for growth. More recently, researchers were able to move beyond simple correlations and establish a convincing causal link running from finance to growth. While there have been dissenting views, today it is accepted that finance is not simply a by-product of the development process, but an engine propelling growth.1 This, in turn, was one of the key elements supporting arguments for financial deregulation. If finance is good for growth, shouldn’t we be working to eliminate barriers to further financial development?
It is fair to say that recent experience has led both academics and policymakers to reconsider their prior conclusions. Is it true regardless of the size and growth rate of the financial system? Or, like a person who eats too much, does a bloated financial system become a drag on the rest of the economy?
In this paper, we address this question by examining the impact of the size and growth of the financial system on productivity growth at the level of aggregate economies. We present two very striking conclusions. First, as is the case with many things in life, with finance you can have too much of a good thing. That is, at low levels, a larger financial system goes hand in hand with higher productivity growth. But there comes a point – one that many advanced economies passed long ago – where more…