Financial Development, Interest Rate Liberalization, and Macroeconomic Volatility

Abstract

This article examines the relationship between financial development, interest rate liberalization, and macroeconomic volatility in fifty-six emerging and developed economies over the period 1980–2009. We find that financial development plays a significant role in dampening the volatility of macroeconomic growth rate, but up to a limit. The more the interest rate is liberalized, the more likely that financial development can stabilize the economy. Particularly, interest rate liberalization has a more positive influence on emerging and developing countries. Financial development and interest rate liberalization can also alleviate the influence of external shocks. They mutually enhance their functions as economic stabilizers.

KEY WORDS:

• financial development
• interest rate liberalization
• macroeconomic volatility

Acknowledgments

The authors thank the editor, Ali M. Kutan, and two anonymous referees for comments that substantially improved this article.

Notes

^1. Gloede and Rungruxsirivorn (2013) provide new micro-evidence on the relationship between financial development and welfare. The results show that financial development is associated with a larger volume of productive investments and is also able to improve the financing of consumption.

^2. Qichun and Meng (2013) also using macro-level panel data for the period of reforms in the Chinese provinces and suggest that financial reform has a significant positive effect on the share of short-term loans allocated to agriculture and a significant negative effect on the share of short-term loans allocated to industry.

Additional information

Funding

The authors acknowledge financial support from Ministry of Education of China (Grant no. 13JJD810006) and form The Education Department of Liaoning Province (Grant no. ZJ2014004).