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Volatility and Growth: An Explanation for the Disagreement

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  • Michael Jetter

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Abstract

This paper reconsiders the effects of volatile growth rates on growth itself. I show that the underlying endogeneity of government size can hide the net growth effects from volatility. There exists a positive direct and a negative indirect channel, with the latter operating through the size of the public sector. Risk-averse citizens respond to volatility either with precautionary savings (direct effect) or by demanding a stronger public safety net, which in turn lowers growth (indirect effect). However, the indirect channel is only available if the political regime allows citizens to determine their desired level of public services. I test this theory on a balanced panel of 95 countries from 1960 { 2010. The paper reveals the latent endogeneity of government size in a single growth equation framework and offers a simultaneous estimation method as an alternative. Results support the existence of both effects. The direct channel is stronger in autocratic societies, but as a country turns to democracy the indirect channel dominates. Volatility has a positive net effect on growth in autocratic nations, but a negative net effect in democratic societies. This finding explains why previous growth analyses of volatility at times reached contradicting conclusions.

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Bibliographic Info

Paper provided by UNIVERSIDAD EAFIT in its series DOCUMENTOS DE TRABAJO CIEF with number 010944.

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Length: 24
Date of creation: 26 Jun 2013
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Handle: RePEc:col:000122:010944

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Keywords: Volatility; Business Cycles; Economic Growth;

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