while corporate indebtedness continued to rise for another two years. The EC estimated that the additional deleveraging need is about 30% of GDP for the private sector.<sup>73</sup> Rising house prices will help households; in Ireland and Portugal prices started increasing again in 2013, Ireland began to see some large increases in 2014‐2015, amounting to 14% per quarter, and in Spain as late as mid‐ 2014. Recent analysis has shown that firms’ employment and investment decisions in response to positive or negative shocks depend on their level of indebtedness (Goretti and Souto, 2013). High leverage firms tend to raise employment and investment less in response to positive shocks than low leverage firms.

**Table 9: Debt of households as a percentage of net disposable income (%)**

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Greece 33 38 44 48 55 67 74 83 87 88 105 112 120 122 115 ‐ Ireland ‐ 111 126 147 170 201 226 236 232 241 237 236 229 225 207 ‐ Portugal 107 118 122 124 127 136 141 146 149 151 154 145 144 140 141 138 Spain 84 87 94 102 114 128 144 154 150 145 148 142 141 134 127 ‐ Includes non‐profit institutions serving households. Source: OECD, Financial Indicators.

**Lesson 9: Finance: too much of a good thing may not be a good thing for households or firms; but too little is also bad.**

_<u>The relationship between finance, productivity and innovation is complex. Policies to support growth need to account for these complexities. Also, who borrows, when and how much matters for growth composition and stability.</u>_ _<u>A complex relationship between finance, productivity growth and innovation.</u>_ New research is reassessing the impact of financial sector growth on overall productivity and GDP growth and some work is mentioned here. Finance is a critical input to investment and firms’ growth yet the financial system’s growth needs to be managed so that its contributions do not destabilize economies or undermine the growth process by not allocating resources to their most productive use. One main theme is that financial system growth contributes to growth, but up to a point and/ or under certain conditions. Easterly et al (2000), and Islam (2016) among others show that there are limits to the consumption smoothing abilities of financial systems and that growth beyond this point may increase growth volatility. Arcand et al (2012) find a nonlinear impact of banking depth on growth, as depth increases to very high levels, the additional impact on growth becomes weaker.

Research has found that when private credit outstanding exceeds 110 percent of GDP, the marginal effect of additional financial sector deepening on economic activity becomes negative, both at the economy and industry level. Cecchetti and Kharroubi (CK, 2012) show that when private credit grows to the point where it exceeds GDP growth, it becomes a drag on productivity growth. CK also show that where the financial sector has represented more than 3.5% of total employment, further increases in financial sector size tend to be detrimental to growth. In their empirical work on advanced countries covering the past three decades, they find that compared with a situation where the financial sector’s share in employment is stable, financial booms (employment growth of 1.6% per year) reduce growth in aggregate GDP per worker by roughly one half of 1 percentage point. The authors claim that during 1995‐ 99, for example, the Irish financial sector’s share in total employment (3.84%) was near the maximizing value, but rose to more than 5% in the next five years. They estimate that Irish trend GDP per worker growth could have been as much as 0.4pp higher over the past decade, if employment growth had been

> 73 Intra‐group cross border lending is very high in Ireland where multinational activity is much greater than in the other countries. The difference between consolidated and non‐consolidated debt is around 26%.

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