Determinants of the Duration of Economic Recoveries: The Role of ´Too Much Finance´

This paper explores the effect of financial development on the duration of economic recoveries, considering a sample of 414 economic recoveries observed in 67 countries during the period 1989-2019. We define the duration of economic recovery, as the time it takes the economy to return to its potential output level. Using a continuous-time Weibull duration model, we find that a higher level of financial development tends to prolong the duration of economic recovery. Therefore, our findings indicate that a too highly developed financial system might delay a full recovery after a recession, supporting the notion that there is ´too much financeâ´. In particular, greater size of the underregulated sector of non-banking financial institutions (shadow banks) prolongs the economic recovery. Moreover, the emerging economies, with their generally poorer regulatory frameworks, are more negatively affected by ´too much finance´. Underlining the importance of an effective regulation of the entire financial system, our results also confirm that a higher regulatory quality limits the negative consequences of ´too much finance´.