The Laffer Curve of Macroeconomic Volatility and Growth: Can it be Explained by the Different Nature of Crises?

Abstract:     
Building upon the general consensus that macroeconomic volatility reduces economic growth since Ramey and Ramey (1995), we empirically show - for over 100 countries during the period 1978-2002 - that a moderate degree of volatility can actually be growth-enhancing while very high volatility is clearly detrimental. These results point to the existence of a "Laffer curve" between volatility and growth. We also find evidence that the detrimental effect of high volatility can be mainly attributed to the occurrence of sovereign crises while banking crises reduce volatility for certain model specifications. In sum, the existence of a "Laffer curve" between volatility and growth can be attributed, at least in part, to the different nature of the crisis buffeting each country.

Keywords: Volatility, Economic Growth, Sovereign Crises, Banking Crises, Currency Crises

JEL Classifications: O40, O11

Working Paper Series