Financial Integrational Effects on Macroeconomic Instability in India

Abstract

The nexus between international financial integration and economic growth continues to be one of the most debated issues among macroeconomists, and these debates often raise several issues from the theoretical and policy perspectives. Financial integration can catalyse financial development, improve governance and impose discipline on macropolicies. However, in the absence of a basic pre-existing level of supporting conditions, financial integration can aggravate instability (Khadraoui, 2010) . In addition, economic theory suggests that increased financial openness intensifies macroeconomic instability. This article investigates the financial integrational effects on macroeconomic instability in terms of output, consumption and investment volatility by employing the vector error correction model (VECM) with empirically reasonably parameters for an emerging economy,India, for the period 1989-2014. From the results, it is evident that financial openness has had a significant effect on output, consumption and investment volatility. Financial development has had a statistically significant negative effect on output, consumption and investment volatility. Similarly, trade openness and terms of trade significantly influence output, consumption and investment volatility.