## Revisiting the Link Between Finance and Macroeconomic Volatility

_IMF Working Papers, January 30, 2013_

## Source details

**Canonical URL:** [Revisiting the Link Between Finance and Macroeconomic Volatility](https://www.imf.org/en/publications/wp/issues/2016/12/31/revisiting-the-link-between-finance-and-macroeconomic-volatility-40284)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/31/revisiting-the-link-between-finance-and-macroeconomic-volatility-40284/index.md)
- [Structured JSON version](/en/publications/wp/issues/2016/12/31/revisiting-the-link-between-finance-and-macroeconomic-volatility-40284/index.json)
- [Bundle manifest](/en/publications/wp/issues/2016/12/31/revisiting-the-link-between-finance-and-macroeconomic-volatility-40284/bundle-manifest.json)

## Bibliographic details
- Authors: Era Dabla-Norris, Narapong Srivisal
- Published: January 30, 2013
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475543988.001

---

### Summary findings
- The paper examines the impact of financial depth on macroeconomic volatility using a dynamic panel analysis for 110 advanced and developing countries.
- Financial depth plays a significant role in dampening the volatility of output, consumption, and investment growth, but only up to a certain point.
- At very high levels of financial depth, such as those observed in many advanced economies, financial depth amplifies consumption and investment volatility.
- Deeper financial systems serve as shock absorbers, mitigating the negative effects of real external shocks on macroeconomic volatility.
- The smoothing effect is particularly pronounced for consumption volatility in environments of high exposure—when trade and financial openness are high—suggesting significant gains from further financial deepening in developing countries.

### Evidence on thresholds and nonlinear effects
- Financial depth reduces volatility for output, consumption, and investment growth up to a threshold; beyond that threshold, financial depth amplifies consumption and investment volatility.
- Very high levels of financial depth are associated with amplification (rather than attenuation) of consumption and investment volatility in many advanced economies.

### Shock absorption and openness
- Strong evidence that deeper financial systems mitigate the negative effects of real external shocks on macroeconomic volatility.
- The mitigation (smoothing) effect is especially strong for consumption volatility when exposure is high (high trade and financial openness).
- Findings imply potential welfare gains from further financial deepening in developing countries exposed to external shocks.

### Policy implications and interpretation
- Financial deepening can reduce macroeconomic volatility, but benefits are nonlinear and may reverse at very high depth levels.
- Policymakers in developing countries with lower or moderate financial depth can expect significant volatility-reducing gains from further financial development.
- Advanced economies with very deep financial systems should recognize potential risks of increased consumption and investment volatility associated with further deepening.

---

## Content in this bundle

- **_wp1329**
  - [_wp1329 (Markdown version)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1329.pdf.md){rel="alternate" type="text/markdown"}
  - [_wp1329 (PDF)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp1329.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/revisiting-the-link-between-finance-and-macroeconomic-volatility-40284_