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Financial Development, Shocks, and Growth Volatility

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  • Mallick, Debdulal

Abstract

This paper argues that studying the effect of financial development and shocks on aggregate growth volatility will not be informative because they affect growth volatility through its different components. Volatility declines either a consequence of a change in the nature of shocks or a change in how the economy reacts to shocks. If two economies differ only in terms of volatility of shocks experienced, the GDP growth spectrum of one economy will lie proportionately below that of another at all frequency ranges so that both business cycle and long-run variances will be lower. Conversely, if change in volatility is due to propagation mechanism such as financial development, a country having developed financial markets will have disproportionately lower variance at the business cycle than at other frequencies relative to that of a country having less developed financial markets. Therefore, the variance at only the business cycle frequency range will be influenced by financial development. The novelty of this paper is that different components of growth volatility are extracted using spectral method. Empirical evidence provides qualified support for both hypotheses. Higher private credit, which is used as proxy of financial development, dampens business cycle volatility but not the long-run volatility. Shocks, as measured by changes in the terms of trade, affect both business cycle and long-run volatility negatively. These results are robust to alternative market-based measure of financial development, and corrections for reverse causality. These results have important implications for growth theory as they shed lights on the factors causing permanent and transitory deviations from the steady state.

Suggested Citation

  • Mallick, Debdulal, 2009. "Financial Development, Shocks, and Growth Volatility," MPRA Paper 17799, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:17799
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    Cited by:

    1. Rodolfo Cermeño & María José Roa, 2013. "Desarrollo financiero, crecimiento y volatidad: Revisión de la literatura reciente," Documentos de Investigación - Research Papers 9, Centro de Estudios Monetarios Latinoamericanos, CEMLA.
    2. Jensen, Henrik & Ravn, Søren Hove & Santoro, Emiliano, 2018. "Changing credit limits, changing business cycles," European Economic Review, Elsevier, vol. 102(C), pages 211-239.
    3. repec:cml:moneta:v:iv:y:2016:i:2:p:195-232 is not listed on IDEAS
    4. Silva, Sergio H.R. da & Tabak, Benjamin M. & Cajueiro, Daniel O. & Fazio, Dimas M., 2017. "Economic growth, volatility and their interaction: What’s the role of finance?," Economic Systems, Elsevier, vol. 41(3), pages 433-444.
    5. Emiel van Bezooijen & Jacob Bikker, 2017. "Financial structure and macroeconomic volatility: a panel data analysis," DNB Working Papers 568, Netherlands Central Bank, Research Department.
    6. repec:eee:jimfin:v:79:y:2017:i:c:p:99-114 is not listed on IDEAS
    7. Rodolfo Cermeño & María Roa García & Claudio González-Vega, 2012. "Financial Development and Volatility of Growth: Time Series Evidence for Mexico and USA," DEGIT Conference Papers c017_035, DEGIT, Dynamics, Economic Growth, and International Trade.
    8. Chowdhury, Mohammad Tarequl H. & Bhattacharya, Prasad Sankar & Mallick, Debdulal & Ulubaşoğlu, Mehmet Ali, 2014. "An empirical inquiry into the role of sectoral diversification in exchange rate regime choice," European Economic Review, Elsevier, vol. 67(C), pages 210-227.

    More about this item

    Keywords

    Financial development; growth volatility; business cycle; spectral analysis;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • O50 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - General
    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models

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