New research published in the Federal Reserve’s Finance and Economics Discussion Series shows that liberalizing banking regulation can boost private credit and stimulate GDP growth in the short term, but it also heightens the likelihood of financial crises. The authors built a cross-country database covering 21 regulatory indicators for 18 advanced economies since World War II and distinguished reforms that directly relax credit supply from broader financial changes. Liberalizations that expand credit supply produced significant rises in private borrowing, mainly in non-tradable sectors, without raising interest rates or credit spreads in the short run. Real GDP grew over the following two to four years, but the gains proved temporary; GDP eventually returned to trend and the risk of crisis rose. The study concludes that only credit-expanding liberalizations generate boom-bust dynamics, and welfare gains depend on a risk‑aversion coefficient below 7.2.
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