find the set of relevant development indicators, we employ a variable-selection procedure which reduces the number of possible indicators from 42 to about 10. The set of possible development indicators is combined from the FinStats database of Al-Hussainy _et al._ (2010), the Financial Structure database of Beck _et al._ (2000) and various supervisory structure and public governance indicators constructed in Kaufmann _et al._ (2010) and Melecky and Podpiera (2012). By explicitly modelling the variation of the parameters that determine equilibrium credit with our selected set of indicators, we account for the countryspecific level of economic, financial and institutional development and are thus able to more precisely detect excessive credit provision.

We provide empirical evidence to suggest that the credit-to-GDP ratio, which restricts the response of credit to GDP and the GDP deflator to unity, is an inappropriate indicator to determine equilibrium credit. Empirical evidence of this is twofold. We first estimate the aggregate cross-country averages of the income and price elasticities of credit within the MG framework and test the unit elasticity hypothesis. This hypothesis is strongly rejected for the income elasticity of credit, and rejected at the 5% level for the price elasticity of credit. The MG estimate of the price elasticity of credit shows substantial variation and is, in fact, not significantly different from zero. We then inspect the cross-country distribution of the income elasticity of credit and find strong evidence of bi-modality. We use the PMG estimation framework to test for cross-country homogeneity of the income and price elasticities and find that this hypothesis is also strongly rejected by the data.

We show further that the cross-country variation in the elasticities is significantly related to the level of development of the countries in our sample. The main development indicators that explain the variation in equilibrium credit elasticities are: financial depth, access to financial services, use of capital markets, efficiency and funding of domestic banks, central bank independence, the degree of supervisory integration, and the experience of a financial crisis. In addition, countries located in Europe and Central Asia show a slower adjustment speed of actual credit to its long-run equilibrium than other countries in our sample.

Based on our findings, we recommend that a structural approach be used to determine equilibrium credit provision to the real economy to avoid any potential negative effects on economic growth in developing countries, due to the implementation of overly restrictive macroprudential policy. The overall objective of our structural estimation of equilibrium credit is to strike a better balance between managing macro-financial risks and facilitating financial development in support of sustained and stable economic growth.

The remainder of the paper is organized as follows. Section 2 discusses the economic motivation behind the proposed empirical approach. Section 3 describes the econometric methodology employed in the paper and the data used in the construction of the different variables of interest. Section 4 presents the empirical results and provides a discussion 5