Departmental Bulletin Paper ‘More Finance’ or ‘Better Finance’ in Output Growth Volatility Literature : Evidence from a Global Perspective

Raheem, Ibrahim D.

30pp.61 - 68 , 2016-03 , The Institute of Comparative Economic Studies, Hosei University
This paper extends the work of Beck et al. (2006, Financial intermediary development and growth volatility : Do intermediaries dampen or magnify shocks? Journal of International Money and Finance 25, 1146-1167) by expanding the measures of finance to capture the qualitative and efficiency nature of the financial sector, rather than measuring the size of the sector. The study used a large dataset for 71 countries covering the period 1999-2011 and relied on system-GMM estimates. It was found that “more finance” (i.e quantitative measures) indicators have strong evidence of dampening effect on output growth volatility, while the “better finance” (efficiency measures) indicators have weak evidence of output growth volatility reducing influence. The exact effect of both monetary and real shocks is mixed across the different measures of financial development. The interaction between financial development indicators and the two sources of shocks indicates that the output volatility reduction arising from the shock is enhanced in the presence of “better finance or qualitative finance”. This concretely reinforces the superior role of “better finance” in mobilizing, distributing and utilizing saving to mitigate against shocks within these economies. The results are robust to different checks and as a policy implication, the study advocates for reforms of the financial sector.

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