Economists Fabiano Schivardi, Enrico Sette and Guido Tabellini 5 show how the health of the banking system influences capital allocation. They estimate that credit misallocation in Italy reduced annual GDP growth by between 0.2 and 0.35 percentage point in the 2008 to 2013 period. What we see, therefore, is that providing liquidity is a balancing act for central banks.
Not providing enough liquidity could cause a spark to turn into a fire, while providing too much liquidity, and thus keeping “zombie banks” on life support, could cause the foundation of our competitive economic system to become brittle and shaky. This dilemma cannot be resolved by monetary policy on its own.