The Effects of Volatility on Growth and Financial Development through Capital Market Imperfections
AbstractThis paper provides a model to account for the empirical evidence that volatility reduces growth. In the model, greater volatility increases the cost associated with capital market imperfections and induces the financial intermediaries to charge higher interest rates. The model is based on one of overlapping generations with two types of technologies. The more productive technology requires fixed investment in the first period. Individual with income less than the amount of fixed investment may borrow in financial markets to obtain more productive technology. Increase in volatility raises the cost of borrowing and makes it less attractive to invest in more productive technology for individuals below certain income in the first period. Hence, volatility reduces growth by deterring people from taking advantage of more productive technology. This model also explains the empirical findings of Ramey and Ramey (1995) that investment is not the channel between volatility and growth by suggesting that totals factor productivity rather than the total factor accumulation is the key for growth.
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Bibliographic InfoPaper provided by Bogazici University, Department of Economics in its series Working Papers with number 2006/12.
Date of creation: Dec 2006
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Other versions of this item:
- Aysan, Ahmet Faruk, 2006. "The Effects of Volatility on Growth and Financial Development through Capital Market Imperfections," MPRA Paper 5486, University Library of Munich, Germany.
- E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
- O40 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
- G20 - Financial Economics - - Financial Institutions and Services - - - General
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