Expansion of Financial Credit Eventually Leads to Negative Growth

VoxEU: Too Much Finance?

"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 (simple regressions and semi-parametric estimations) and data (country-level and industry-level). The threshold at which we find that financial development starts having a negative effect on growth is similar to the threshold at which Easterly et al. 2000 find that financial development starts increasing volatility. This finding is consistent with the literature on the relationship between volatility and growth (Ramey and Ramey 1995) and that on the persistence of negative output shocks (Cerra and Saxena 2008)."

The Credit Crisis as a Valorization Problem

Naked Capitalism has a great guest post today which exposes the incentivization process at work in the credit system:

"One source of credit market friction arises from coordination failures among lenders (see for example Gorton and He 2008). In these models, banks are heterogeneous and their behaviour strategic. The individually rational actions of heterogeneous lenders can generate collectively sub-optimal credit provision in both the upswing (a credit boom) and the downswing (a credit crunch). This is a collective action, or co-ordination, problem among banks.

...

"In the face of stiffening competition, banks were increasingly required to keep pace with the returns on equity offered by their rivals – a case not so much of “keeping up with the Joneses” as “keeping up with the Goldmans”."

So we see that the underlying cause of the expansion of credit is the valorization of capital. Not only the simple valorization, but the competition for capital (which I hope to cover soon on its own right) serves as an important ossifying process for companies which cannot necessarily sustain this model: