19 Pages Posted: 25 Oct 2015

Date Written: October 23, 2015

Abstract

This paper evaluates recent findings by researchers at the Organization for Economic Cooperation and Development (OECD) on "too much finance." It first critiques the OECD findings, which seem to imply that the optimal amount of finance is zero, given the linear specification of the main tests. It then finds that the negative impact of additional finance on growth is reversed when the appropriate (purchasing-power-parity) per capita income is applied and country fixed effects are removed. Separate tests for countries with intermediated finance below and above 60 percent of GDP show a significant positive effect of finance on growth in the lower group but an insignificant effect in the higher group. An appendix replies to critics of my earlier study (Cline 2015b) in which I argued that an estimated negative quadratic effect of finance on growth was likely to be a spurious correlation reflecting convergence-based lower growth at higher per capita incomes. It notes that the critics' own logarithmic tests, yielding a positive marginal impact of finance on growth even at high levels, achieve comparable explanation to their quadratic form yielding a negative marginal impact. It finds that adding dummy variables for below and above intermediate financial depth to the logarithmic form does not support the inverse U influence found in the quadratic form.