Volatility and Growth

It has long been recognized that productivity growth and the business cycle are closely interrelated. Yet, until recently, the two phenomena have been investigated separately in the economics literature.

This book provides the first consistent attempt to analyze the effects of macroeconomic volatility on productivity growth, and also the reverse causality from growth to business cycles. The authors show that by looking at the economy through the lens of private entrepreneurs, who invest under credit constraints, one can go some way towards explaining persistent macroeconomic volatility and the effects of volatility on growth.

Beginning with an analysis of the effects of volatility on growth, the authors argue that the lower the level of financial development in a country the more detrimental the effect of volatility on growth. This prediction is confirmed by cross-country panel regressions. The data also suggests that a fixed exchange rate regime or more countercyclical budgetary policies are growth-enhancing in countries with a lower level of financial development. The former reduce aggregate volatility whereas the latter reduce the negative effects of volatility on long-term productivity-enhancing investment by firms.

The book concludes with an investigation into how the interplay between credit constraints and pecuniary externalities is sufficient to generate persistent business cycles and to explain the occurrence of currency crises.

Philippe Aghion, Robert C. Waggoner Professor of Economics, Harvard University,Abhijit Banerjee, Ford Foundation International Professor of Economics and Director Poverty Action Lab, MIT

Philippe Aghion is Robert C. Waggoner Professor of Economics at Harvard University. He has held positions at MIT, the French CNRS, the University of Oxford, and University College London, and joined the Harvard faculty in 2000. In 2001 he received the Yrjo Jahnsson Award of the European Economic Association and in 2020 he shared the BBVA Frontier of Knowledge Award with Peter Howitt.

Abhijit Banerjee is Ford Foundation International Professor of Economics and Director of the Poverty Action Lab at MIT. He was a past President of the Bureau for Research in Economic Analysis and Development (BREAD). He received his Ph.D. in economics from Harvard University, and has taught at Princeton and Harvard before joining the MIT faculty in 1996. He is a 2019 Nobel Prize Winner for Economic Sciences.