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Journal of Economic Perspectives: Vol. 27 No. 2 (Spring 2013)

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Finance: Function Matters, Not Size

Article Citation

Cochrane, John H. 2013. "Finance: Function Matters, Not Size." Journal of Economic Perspectives, 27(2): 29-50.

DOI: 10.1257/jep.27.2.29

Abstract

It's fun to pass judgment on waste, size, usefulness, complexity, and excessive compensation. But as economists, we have an analytical structure for thinking about these questions. "I don’t understand it" doesn't mean "it's bad," or "regulation will improve it." That attitude pervades policy analysis in general and financial regulation in particular, and economists do the world a disservice if we echo it. I will not offer a competing black box [to explain the size of the finance industry]. I don’t claim to estimate the socially optimal "size of finance" at, say, 8.267 percent of GDP. It's just the wrong question. Hayek and the failure of planning should teach us a little modesty: Pronouncing on socially optimal industry size is a waste of time. Is the finance industry functioning well? Are there identifiable market or government distortions? Will proposed regulations help or make matters worse? These are useful questions.

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Authors

Cochrane, John H. (U Chicago)

JEL Classifications

E23: Macroeconomics: Production
E44: Financial Markets and the Macroeconomy
G10: General Financial Markets: General (includes Measurement and Data)
G20: Financial Institutions and Services: General

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