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ON RECESSIVE AND EXPANSIONARY IMPACT OF FINANCIAL DEVELOPMENT: Empirical evidence

Nguena, Christian L. and Kodila-Tedika, Oasis (2017): ON RECESSIVE AND EXPANSIONARY IMPACT OF FINANCIAL DEVELOPMENT: Empirical evidence.

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Abstract

We analyse the effects of financial development on recession while controlling for potential recession factors in 129 countries using data covering the 1990-2010 period. We mainly found a nonlinear and U-shaped relationship between recession and financial development with a threshold effect of 1.1528. The financial development process presents an expansionary impact for countries with financial performance less than 1.1528, and countries with financial performance above the threshold of 1.1528 present a recessionary impact. Moreover, fuels for South Asia (SASIA) and Latin America and Caribbean (LAC) countries and financial openness for sub-Saharan Africa (SSA) countries are negatively related to recessions; countries who manage their oil production in a good manner will also reduce the probability and impact of recessions. Thus, to fight against recession, SASIA and LAC countries should well manage oil production and usage while SSA countries may manage their financial openness. To the best of our knowledge, this is the first study examining this relationship using newly primary and hitherto almost unexploited “Rare macroeconomic disasters” data from Barro and Ursua (2012) which allow us to build a more specific proxy of the variable “economic recession”. The nexus between recession and financial development assessment suggest that, the nonlinearity and thus U-shaped relationship is operational; additionally, when financial development increases, it is accompanied by a reduction in the depth of recessions; and this, up to a certain threshold. Beyond this brink, financial deepening correlates with deep recessions. Additionally, we found that trade openness have a positive on economic recession independently to the estimation method. For robustness check, estimations results first confirm the baseline findings in terms of magnitude and significance in the correlation coefficients; then, highlight sub-Saharan Africa (SSA), South Asia (SASIA) and Latin America and Caribbean (LAC) as the order of continental/regional importance in increasing magnitude. Finally, the semiparametric regression show that, the results of the parametric part converge with the previous results in general, and bear out with illustration the functional form of the nonlinear relation between recession and financial development. To the best of our knowledge, this is the first study examining this relationship using newly primary and hitherto almost unexploited “Rare macroeconomic disasters” data from Barro and Ursua (2012) which allow us to build a more specific proxy of the variable “economic recession”.

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