Financial development,sectoral reallocation,and volatility: International evidence |
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| Institution: | 1. University of Bristol, United Kingdom;2. Bank of England, United Kingdom;1. Department of Economics, Wake Forest University, Kirby Hall, Box 7505, Winston-Salem, NC 27109, United States;2. Department of Economics, Chinese University of Hong Kong, 914, Esther Lee Building, Chung Chi Campus, Shatin, Hong Kong;1. Graduate Institute of International and Development Studies, Switzerland;2. CEPR, United Kingdom;3. Banque de France, France;4. CEPII, France;5. University of Lille, LEM-CNRS (UMR 9221), France |
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| Abstract: | This paper studies how financial development affects the volatility of GDP growth through the channel of sectoral reallocation. For 28 OECD countries over the period 1970–2007, we construct a benchmark industrial portfolio that minimizes the economy's long-term volatility for a given level of long-term labor productivity growth. We find that financial development substantially increases the speed with which the observed industrial composition of output converges toward the benchmark. To overcome endogeneity concerns, we exploit sectoral sensitivities to financial deepening and exogenous liberalization events. |
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