Financial Deepening, Terms of Trade Shocks, and Growth Volatility in Low-Income Countries
36 Pages Posted: 25 Apr 2019
Date Written: March 2019
This paper contributes to the literature by looking at the possible relevance of the structure of the financial system-whether financial intermediation is performed through banks or markets-for macroeconomic volatility, against the backdrop of increased policy attention on strengthening growth resilience. With low-income countries (LICs) being the most vulnerable to large and frequent terms of trade shocks, the paper focuses on a sample of 38 LICs over the period 1978-2012 and finds that banking sector development acts as a shock-absorber in poor countries, dampening the transmission of terms of trade shocks to growth volatility. Expanding the sample to 121 developing countries confirms this result, although this role of shock-absorber fades away as economies grow richer. Stock market development, by contrast, appears neither to be a shock-absorber nor a shock-amplifier for most economies. These findings are consistent across a range of econometric estimators, including fixed effect, system GMM and local projection estimates.
Keywords: Financial sector development, Economic stabilization, Real sector, International capital markets, Terms of trade, Banks, stock markets, terms of trade shocks, growth volatility, volatility, GMM, financial development, shock-absorber, sector development
JEL Classification: F4, G20, O1, F40, O10, E01, G21, L31, E52, G2
Suggested Citation: Suggested Citation