Finance and Growth: When Credit Helps, and When it Hinders

The financial sector can both support growth and cause crises. The crisis has revealed gaps in economists’ understanding of this dual potential.

This paper argues for a different approach based on the credit nature and the older distinction made between credit flows, which grow the economy (the GDP), and credit which inflates the markets of financial assets and real estate. It can also boost the real sector by increasing the debt-to-GDP ratio. If it overshoots, it can lead to bloated markets, capital gains being pursued instead of profit, and rising costs because of high asset values. Overshooting occurs because of the nature and structure of money, banks, and compound interest. Deregulation of the financial sector leads to credit booms and then busts.

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