How Do Trade and Financial Integration Affect the Relationship Between Growth and Volatility?

International Monetary Fund, Research Department, Washington, DC 20431, United States
Journal of International Economics 03/2005; 05(1):176-202. DOI: 10.1016/j.jinteco.2005.05.009
Source: RePEc


The influential work of Ramey and Ramey [Ramey, G., Ramey, V.A., 1995. Cross-country evidence on the link between volatility and growth. American Economic Review 85, 1138–1151 (December).] highlighted an empirical relationship that has now come to be regarded as conventional wisdom—that output volatility and growth are negatively correlated. We reexamine this relationship in the context of globalization—a term typically used to describe the phenomenon of growing international trade and financial integration that has intensified since the mid-1980s. Using a comprehensive new data set, we document that, while the basic negative association between growth and volatility has been preserved during the 1990s, both trade and financial integration significantly weaken this negative relationship. Specifically, we find that, in a regression of growth on volatility and other controls, the estimated coefficient on the interaction between volatility and trade integration is significantly positive. We find a similar, although less robust, result for the interaction of financial integration with volatility.

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Available from: Eswar S. Prasad, Dec 18, 2013
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    • "Since the seminal empirical work of Ramey and Ramey [13], the relationship between mean growth and growth volatility has been abundantly studied. More recent evidence provided by Kose et al. [7] [8] show that such relationship has been affected by both trade and financial liberalization. In theory, though, few studies have addressed the growth-volatility relationship in the context of international risk sharing and our analysis hopefully contributes to filling this gap. "
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    • "Therefore, the de facto measure, which we also choose, is a more realistic tool to assess financial liberalization. (See Kose et al. (2006) on the shortcomings of de jure measures.) Although both de jure and de facto measures are examined in this study, it will mainly adopt the de facto measure types, which are the FDI plus portfolio in-and out-flows, foreign assets plus foreign liabilities and the stock of FDI plus portfolio flows. "
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    • "6 The advantage of specialization in sectors where a country has comparative advantages goes back to the classical Ricardo and Hecksher-Ohlin-Mundell trade models (see, e.g., Dornbusch et al., 1977). The trade-off between the productivity gains from specialization and the increased vulnerability to external shocks is established theoretically in Easterly et al. (2000), and verified empirically for emerging economies in Kose et al. (2006) "
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