An empirical refinement of the relationship between growth and volatility

Abstract

The link between business cycle volatility and the long-run growth rate has received increasing attention in the literature over the last ten years. Yet neither is there a theoretical consensus nor consistent empirical evidence that would lead us to believe the relationship is positive, negative or nonexistent either within broadly defined regions or over time. This study investigates a possible cause for this phenomenon. What we find is that out of 14 popularly defined sub regions, only 7 can be constrained over time within the respective sub region, while only two broadly-defined regional classifications are justified. We did find that the grouping of OECD countries is statistically valid, but only if the relationship is allowed to vary over time. We suggest a refinement of the current empirical work that takes into account both more narrowly defined regional and time parametric heterogeneity.

GDP Fluctuations and Long-Run Economic Growth: A Study of Selected South Asian Countries

“…Under this scenario, if agents jointly choose the riskier technologies in a volatile environment, then the growth should be higher in subsequent periods. Thirdly, as pointed out by Edwards and Yang (2009) and Hnatkovska and Loayza (2004) another possible mechanism for a positive relationship is associated with the concept of creative destruction. If these fluctuations are linked with the occurrence of recessions and these recessions lead to higher research and development along with the destruction of least productive firms, then higher long-run growth can occur alongside higher volatility [Aghion andSaint-Paul (1998a), (1998b)].…”

“…After a review of the existing available literature, there seems an undisputed view that GDP volatility is related to long-run growth in some way. However, there is neither a theoretical agreement nor reliable empirical evidence that may guide us to consider that the relationship is negative, positive or nonexistent [Edwards and Yang (2009)]. For example, Imbs (2002) says that links between fluctuations and growth might be positive or negative, depending on the mechanisms driving this relationship.…”

“…Theoretically, on the one hand, links between GDP fluctuations and long-run growth may be positive, for instance, Edwards and Yang (2009) pointed-out the three different channels suggesting a positive link between GDP volatility and growth. A diagrammatic representation of this positive link between growth and fluctuations is shown in Figure 1.…”

“…An increase in volatility and uncertainty makes the consumer more inclined to save which results in increased investment and thus higher output growth [Sandmo (1970, Mirman (1971]. Secondly, according to Edwards and Yang (2009) the positive volatility-growth links can be derived through channel of agents' choice between high-expected-return technologies and or low-expected-return technologies [Black (1987)]. Under this scenario, if agents jointly choose the riskier technologies in a volatile environment, then the growth should be higher in subsequent periods.…”

“…On the other hand, the theoretical work has also presented the possibility of a negative link between growth and GDP volatility. Hnatkovska and Loayza (2004) and Edwards and Yang (2009) have discussed some scenarios to show the negative growth-volatility link. A diagrammatic representation of this negative link between growth and fluctuations is shown in Figure 2.…”