Bank Lending to the Private Sector and GDP Growth: Thresholds and Returns

We examine the relationship between lending to the private sector and GDP growth using a two-period model and test model conclusions through a Smooth Transition Conditional Correlation (STCC) model for the G7 countries. Theory suggests that the correlation between private lending and growth is positive and this relationship exhibits diminishing returns after a threshold. The empirical exercise confirms that this relationship holds, and while thresholds exist for most countries, the correlation between private lending and growth is never negative. Overall, the evidence indicates that policy should not emphasise the level of lending but its allocation in the economy.