When credit creation helps and hurts, Financialization of economies
Below is a talk by Dirk Bezemer from the INET conference. It is excellent, and is well worth 25 minutes of your time. Is the financial sector inherently evil? The answer is no. It has a role in all modern economies by factilitating the dispersion of resources. There is a cost (inefficiency) associated with this, but for low levels of bank credit creation more good than harm occurs. But there becomes a point when the finacial sector and financial transactions becomes so large that credit flow to the real economy (which support captial formation) is far outpaced by credit flow to financial and asset markets, which create bubbles and eventually instability.
As I discuss in Section 5 of this post: http://marketthoughtsandanalysis.blogspot.com/2011/08/why-deficit-spending-and-creative.html#Section5, the finanical system that we have today (in the US and in most developed economies) need to be only a small fraction of the size the currently are in order to receive the positive economic benefit from them. Their sheer size now is what has caused the most recent crisis and the fact that their size was not reduced in the last crisis means that they present a futher and ongoing systemic risk.
The risk is that size of the bank debt and the drain from the real economy needed service that debt will precipate another crisis. We cannot even address this problem until we address the size of the finanical system which maintains that debt. Which is the main topic that I discuss in Section 6
How can we create a financial system that is socially useful?
INET Conference 2012