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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:

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    2. Zouaoui, Haykel & Mazioud, Manel & Ellouz, Nidhal Ziedi, 2018. "A semi-parametric panel data analysis on financial development-economic volatility nexus in developing countries," Economics Letters, Elsevier, vol. 172(C), pages 50-55.
    3. Britta Gehrke & Fang Yao, 2016. "Persistence and volatility of real exchange rates: the role of supply shocks revisited," Reserve Bank of New Zealand Discussion Paper Series DP2016/02, Reserve Bank of New Zealand.
    4. Rodolfo Cermeño & María José Roa, 2013. "Desarrollo financiero, crecimiento y volatidad: Revisión de la literatura reciente," Documentos de Investigación - Research Papers 9, CEMLA.
    5. Rodolfo Cermeño & María José Roa García & Claudio González-Vega, 2016. "Financial Development and the Volatility of Growth: Time Series Evidence for Mexico and United States," Monetaria, Centro de Estudios Monetarios Latinoamericanos, CEMLA, vol. 0(2), pages 195-232, july-dece.
    6. 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.
    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.
    9. Abdul Rahman & Muhammad Arshad Khan, 2024. "Role of consistent regime-specific policies in recovering the negative relationship between financial development and economic growth," Economic Change and Restructuring, Springer, vol. 57(4), pages 1-27, August.
    10. Silva, Thiago Christiano & Tabak, Benjamin Miranda & Laiz, Marcela Tetzner, 2021. "The finance-growth nexus: The role of banks," Economic Systems, Elsevier, vol. 45(1).
    11. Summaira Malik & Ali Abbas & Malik Shahzad Shabbir & Carlos Samuel Ramos-Meza, 2024. "Business Cycle Fluctuations, Foreign Direct Investment, and Real Effective Exchange Rate Nexus Among Asian Countries," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 15(2), pages 5466-5479, June.
    12. Jensen, Henrik & Ravn, Søren Hove & Santoro, Emiliano, 2018. "Changing credit limits, changing business cycles," European Economic Review, Elsevier, vol. 102(C), pages 211-239.
    13. Gehrke, Britta & Yao, Fang, 2017. "Are supply shocks important for real exchange rates? A fresh view from the frequency-domain," Journal of International Money and Finance, Elsevier, vol. 79(C), pages 99-114.
    14. Ibrahim, Muazu & Alagidede, Paul, 2017. "Financial sector development, economic volatility and shocks in sub-Saharan Africa," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 484(C), pages 66-81.
    15. Meriem Sebai & Omar Talbi & Hella Guerchi Mehri, 2024. "On the Banking Deepening and Economic Volatility Nexus in Emerging Countries: Evidence from a GMM Panel-VAR Approach," International Journal of Research and Innovation in Social Science, International Journal of Research and Innovation in Social Science (IJRISS), vol. 8(5), pages 430-442, May.
    16. Rodolfo Cermeño Bazán & María Roa García & Claudio González Vega, 2012. "Financial Development and Growth Volatility: Time Series Evidence for Mexico and The United States," Working Papers DTE 544, CIDE, División de Economía.

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    More about this item

    Keywords

    Financial development; growth volatility; business cycle; spectral analysis;
    All these keywords.

    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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