Further Evidence on the Link Between Finance and Cyclical Fluctuations

This paper explores the possibility that financial market development mitigates cyclical fluctuations in several developing countries.  The paper uses the GARCH approach to account for the time-varying behavior of macroeconomic volatility, and distinguishes between overall and sectoral macroeconomic volatility.  Results from co-integration and error-correction models suggest that financial market development (alternatively measured) does exert a robust long-term dampening effect on macroeconomic volatility.  In contrast, short-term effects of financial development on cyclical fluctuations are generally tenuous, or non-existent.  These findings imply that financial reforms can contribute to macroeconomic stability, but only if these reforms persist over a prolonged period of time.  The results also suggest that financial reforms impact economic sectors differently across the countries examined.