Stress-Ridden Finance and Growth Losses: Does Financial Development Break the Link?

Abstract

Does financial development shield countries from the pass-through of financial shocks to real outcomes? We evaluate this question by characterizing the probability density of expected GDP growth conditional on financial stability indicators in a panel of 28 countries. Our robust results unveil a non-linear nexus between financial stability and expected GDP growth, depending on countries’ degree of financial development. While both domestic and global financial factors affect expected growth, the effect of global factors is moderated by financial development. This result highlights a previously unexplored channel trough which financial development can break the link between financial (in)stability and GDP growth.

Keywords: economic growth, financial stability, financial development, capital flows, growth at risk