Medium-term macroeconomic volatility and economic development: a new technique

A key question in development economics is why developing countries as a collective group experience so much growth volatility. This paper introduces a new technique to measure medium-term macroeconomic volatility that is defined by the trend-growth volatility of output. It shows that medium-term volatility, $$\sigma _{\mathrm{MT}}^2 $$ σ MT 2 , can be derived by subtracting the average short-term volatility, $$\left( {1/n} \right) \sum _j^n \sigma _{Sj}^2 $$ 1 / n ∑ j n σ Sj 2 , from the total variance of output growth, $$\sigma _{\mathrm{LT}}^2 $$ σ LT 2 . Applying this new measure to the World Bank’s output data reveals an inverted-U shaped relationship between medium-term volatility and economic development, indicating that economic development is likely to increase trend-growth volatility for emerging low-income countries.