Finance – can there be too much of a good thing?

An important policy question is: how big should the financial sector in a country be. Can there be too much finance? A recent IMF working paper by Jean-Louis Arcand, Enrico Berkes, and Ugo Panizza suggests there is a threshold above which financial development no longer has a positive effect on economic growth. They find that finance starts having a negative effect on output growth when credit to the private sector reaches 100% of GDP. Below is a graph of the effect of credit to the private sector on growth that shows this inverted U-shape relation between credit to the private sector and growth.

And here are the countries that are just below or above the optimal level

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