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FINANCIAL DEVELOPMENT, SHOCKS, AND GROWTH VOLATILITY

Published online by Cambridge University Press:  25 March 2013

Debdulal Mallick
Debdulal Mallick*
Affiliation:
Deakin University
*
Address correspondence to: Debdulal Mallick, School of Accounting, Economics and Finance, Deakin University, Burwood, VIC 3125, Australia; e-mail: dmallic@deakin.edu.au.
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Abstract

This paper uses spectral theory to develop the following two testable hypotheses in a unified framework for the predictions of business-cycle and endogenous growth models: (i) financial development affects only business-cycle volatility; and (ii) shocks affect both business-cycle volatility and long-run volatility of GDP growth. In other words, volatility caused by shocks is more persistent than that caused by financial underdevelopment. We decompose the business-cycle and long-run volatility by the spectral method and then test the hypotheses at the cross-country level. Empirical evidence provides support for both hypotheses. Higher private credit, a bank-based measure of financial development, dampens business-cycle volatility but not long-run volatility. Volatility of shocks, as measured by the volatility of changes in the terms of trade, magnifies both business-cycle and long-run volatility. The results are robust to accounting for endogeneity, a market-based measure of financial development, and an alternative method of volatility decomposition.

Keywords

Financial DevelopmentShocksGrowth VolatilityBusiness CycleSpectral Analysis
Type
Articles
Information
Macroeconomic Dynamics , Volume 18 , Issue 3 , April 2014 , pp. 651 - 688
Copyright
Copyright © Cambridge University Press 2013 

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