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Credit and growth: Which drives which?

Ryan Hahn's picture

This is a question that is stalking financial policymakers: Does credit growth drive economic growth, or does growth in the real sector drive credit growth? If the latter, then policymakers in emerging markets might do well to repress the financial system - the likelihood of crises will probably be reduced, while growth will not be harmed. But a new paper provides a bit of evidence that points in the opposite direction. From Does Access to External Finance Improve Productivity:


This paper examines the effect of access to finance on productivity. We exploit an exogenous shift in demand for U.S. corn to expose county-level productivity responses in the presence of varying levels of access to finance. The exogenous shift in demand for corn is due to a boom in ethanol production, which is a result of a number of complementary forces (rising crude oil prices, the Energy Policy Act of 2005, and new federal tax incentives). We find that counties in the midwestern United States with the lowest levels of bank deposits have been unable to increase their corn yields as much as other counties. This result demonstrates the positive impact of access to finance on productivity.

Now, if we could just replicate this kind of study in an emerging market to see whether the results hold... 

Comments

This is an interesting theory. However, the example about Midwestern farmers could have many extraneous variables affecting why they did not increase their corn yields.

Submitted by GS RADJOU on
I think Dr Schumacher's business philosophy still echoes today. The pressure of short termism views seem to be winning at all times (in the short-run). A greater emphasis should be put into entrepreneur/ business person roles in the community and also business transfers and the uncertainty world.

Submitted by GS RADJOU on
According to the period and the type of country, credit can play different roles in growth. I think it is rather true than before the crisis period (2007-2009), credit helped to produce until the tipping point, which is the financial crisis. I mean, all is linked I suppose. There is no financial crisis without the mortgage crisis or the food crisis. It is in the same economic cycle of the investments. Anyway,the leverage of the company does not have to be too important. If not, the firm cannot refund its debt and there is a risk of bankruptcy. Fortunate politicians or business persons can use debt financing to grow. What happens to solve the crisis issue (suppose there is one-I mean in the west because, Asia never went into a crisis with a growth rate of 6% to 10%). We saw business leaders (and also organisation leaders endebting the country a bit more in order (I mean, they should have pried for it) to reduce recovery risks and hamper negative points of the financial disaster (bankruptcy, unemployement,...). Still, for instance Euro pact has been largely overestimated as we know it now because it resisted badly to Greece, Iceland, Poland,...,IMF. Now, the dollar is regaining confidence and a new acceptance. However, I am myself a bit reluctant to think that with this growth rate of 0.1% or 0.2£ or 0.5% or even more organizations will be able, to ensure that citizens are wealthier than before. Hopefully, leaders will make something for it. They get pay for that! In this post period of crisis recovery, I am advocating more innovations and creations.

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