Abstract

We examine the relationship between capital account openness and growth volatility according to the level of financial development condition. We demonstrate that economies with high level of financial sector development benefit more from capital flows than those with a lower one. In what follows, we extend previous studies by employing updated data, and also exploring more questions related to the links between capital movements and growth volatility. More specifically, we will investigate the issues relevant to threshold effect of financial development on which capital flows changes of sign. We investigate the role of financial development in the relationship between capital flows and growth volatility for different groups of countries. Estimations are conducted with a panel data of 70 countries over the period 1970-2009 using GMM-System estimator for dynamic panel data. Empirical results support that capital movements aggravate macroeconomic volatility according to the level of domestic financial development. This implies that countries which are at an intermediate phase of financial development are the most vulnerable to instability. This threshold is estimated at a rate of credits to the private sector to GDP around 50 %.

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