Financial Growth and Crash under Shadow Banking

This article develops a macroeconomic model of interaction between the real sector and the financial sector, and explores the conditions that make the economy vulnerable to sudden collapse as a result of finance-led growth. It extends the Kaleckian framework of the link between profit and investment in a modern financialized economy with some specific features of shadow banking and articulates the underlying dynamics that render the economy systemically fragile and vulnerable to abrupt crashes. We elaborate on this link through a stock-flow consistent accounting framework and study the dynamics through two interacting forces of the shadow banking sector: profit-seeking and liquidity preference. The article formally articulates the dynamics through the framework of ‘cusp catastrophe’ and identifies some early warning signs of potential financial collapse.