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Finance: Economic Lifeblood or Toxin?

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In the past two decades, academic research has produced massive evidence of the beneficial role of financial development for growth and the allocation of investment. Our current vision, however, is dominated by instances of dysfunctional behavior of financial markets associated with acute and widespread crises. This raises the issue of when and why finance ceases to be the “lifeblood” and turns into a “toxin” for real economic activity. This paper is a first step towards an answer. Its thesis is that the metamorphosis occurs when finance becomes “too large” relative to the underlying economy. At this point finance stops contributing to economic growth and comes to threaten the solvency of banks and systemic stability. A related question is why regulation is not designed so as to prevent the financial industry from growing above this threshold. I argue that the answer lies largely in the symbiosis between politicians and the finance industry.

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 326.

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Date of creation: 23 Dec 2012
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Handle: RePEc:sef:csefwp:326

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Keywords: Financial development; financial crisis; risk taking; market failure; political economy;

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Cited by:
  1. Maimbo, Samuel Munzele & Melecky, Martin, 2014. "Financial sector policy in practice : benchmarking financial sector strategies around the world," Policy Research Working Paper Series 6746, The World Bank.

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