We build a simple model finding that, even in the presence of credit rationing, the expectation of a bailout may lead to a financial sector that is too large with respect to the social optimum...In other words, excessively protected financial systems become too big to fail, but fail anyway, implying that, in the world of government regulated finance, too much of a good thing indeed turns out to be a bad thing.
Our results show that the marginal effect of financial development on output growth becomes negative when credit to the private sector surpasses 110% of GDP. This result is surprisingly consistent across different types of estimators...
All the advanced economies that are now facing serious problems are located above our “too much” finance threshold.
Thursday, April 7, 2011
This is the question that Arcand, Berkes and Panizza ask in this Vox article. Here's how they summarize their research: