Financial development and the magnitude of business cycle fluctuations in OECD countries

Abstract

We study empirically how the development of financial systems influences the magnitude of output growth fluctuations in a sample of OECD countries between 1995 and 2005. While the development of banking sectors is not significantly related to the magnitude of macroeconomic fluctuations, countries characterized by developed stock markets experience less pronounced fluctuations.

Keywords:

• business cycle
• financial development
• banking
• stock market

JEL Classification:

• E32
• G21
• G32

Notes

¹ The countries included in our sample are Australia, Austria, Belgium, Canada, Germany, Denmark, Finland, France, Ireland, Italy, Japan, the Netherlands, Norway, New Zealand, Portugal, Spain, Sweden, Switzerland, the United Kingdom and the United States.

² The effect of trade openness on business cycle volatility is controversial in the literature. Di Giovanni and Levchenko (2009) find, using firm level data, that trade openness increases volatility. Haddad et al. (2010) in contrast, find that openness reduces volatility if countries are sufficiently diversified. Cecchetti et al. (2006) document a negative, albeit insignificant, relationship between trade openness and output volatility.