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Financial Development and the Volatility of Income

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  • Tiago Pinheiro
  • Francisco Rivadeneyra
  • Marc Teignier

Abstract

This paper presents a general equilibrium model with endogenous collateral constraints to study the relationship between financial development and business cycle fluctuations in a cross-section of economies with different sizes of their financial sector. The financial sector can amplify or dampen the volatility of income by increasing or reducing the business cycle effects of technological shocks. We find a non-monotonic relationship between the volatility of income and financial development measured by total borrowing and lending. A more developed financial system unambiguously increases the income level however the volatility can rise or fall depending on the degree of financial development.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2013/01/wp2013-04.pdf
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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 13-4.

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Length: 36 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:bca:bocawp:13-4

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Keywords: Credit and credit aggregates; Financial stability;

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  1. Denizer, Cevdet & Iyigun, Murat F. & Owen, Ann L., 2000. "Finance and macroeconomic volatility," Policy Research Working Paper Series 2487, The World Bank.
  2. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
  3. Nobuhiro Kiyotaki & John Moore, 2005. "Financial Deepening," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 701-713, 04/05.
  4. Beck, Thorsten & Levine, Ross & Loayza, Norman, 2000. "Finance and the sources of growth," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 261-300.
  5. Joshua Aizenman, 2004. "Financial Opening and Development: Evidence and Policy Controversies," American Economic Review, American Economic Association, vol. 94(2), pages 65-70, May.
  6. Ali Darrat & Salah Abosedra & Hassan Aly, 2005. "Assessing the role of financial deepening in business cycles: the experience of the United Arab Emirates," Applied Financial Economics, Taylor and Francis Journals, vol. 15(7), pages 447-453.
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