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Finance - Economic Lifeblood or Toxin?

  • Marco Pagano

    (University of Naples "Federico II", CSEF and EIF)

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 Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1309.

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Length: 33 pages
Date of creation: 2013
Date of revision: Apr 2013
Handle: RePEc:eie:wpaper:1309
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