This paper discusses the link between financial development and macroeconomic volatility by exploring some of the ways through which financial development may affect business cycle fluctuations. To be specific, we examine whether stock market development exerts an unambiguous effect on macroeconomic volatility. Building on theoretical work related to two different strands, we also investigate the role financial development has in the propagation of real and monetary shocks. Using a panel data set covering 22 OECD countries over the period 1970 through 2000 we find a robust relationship between stock market development and the severity of the macroeconomic cycle, and evidence that well-developed financial systems magnify monetary shocks and dampen real ones. The results also indicate that the size of the stock market matters when interaction with stock market volatility is controlled for.
Business Cycle Macroeconomic Fluctuation Financial System Stock Market Panel Analysis