Financial Deepening, Terms of Trade Shocks, and Growth Volatility in Low-Income Countries
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Summary:
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.
Series:
Working Paper No. 2019/068
Subject:
Commercial banks Credit Financial institutions Financial markets Financial sector development International trade Money Stock markets Terms of trade
English
Publication Date:
March 25, 2019
ISBN/ISSN:
9781498303569/1018-5941
Stock No:
WPIEA2019068
Pages:
35
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