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How do trade and financial integration affect the relationship between growth and volatility

  • M. Ayhan Kose
  • Eswar S. Prasad
  • Marco E. Terrones

The influential work of Ramey and Ramey (1995) highlighted an empirical relationship that has now come to be regarded as conventional wisdom—that output volatility and growth are negatively correlated. We reexamine this relationship in the context of globalization—a term typically used to describe the phenomenon of growing international trade and financial integration that has intensified since the mid-1980s. We employ various econometric techniques and a comprehensive new dataset to analyze the link between growth and volatility. Our findings suggest that, while the basic negative association between growth and volatility has been preserved during the 1990s, both trade and financial integration attenuate this negative relationship. Specifically, countries that are more open to trade appear to face a less severe tradeoff between growth and volatility. We find a similar, although slightly less robust, result for the interaction of financial integration with volatility. We also investigate some of the channels, including investment and credit, through which different aspects of global integration could affect the growth-volatility relationship.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2004-29.

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Handle: RePEc:fip:fedfwp:2004-29
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