The impact of financial system development on business cycles volatility: cross-country evidence

Abstract

This paper reveals cross-country evidence on how the development of the financial system affects business cycle’s volatility. The link between credit markets and economic activity has been the focus of extensive literature, but no cross-country empirical study relating the volatility of economic fluctuations with the development of the financial system has yet been performed. More developed financial systems should imply a reduced impact of asymmetric information problems, as financial institutions become more capable of identifying projects with higher probability of failure. Using a generalized method of moments technique on cross-section set, this paper shows that countries with more developed financial systems have smoother economic fluctuations.