Volatility and growth: Governments are key

Michael Jetter

European Journal of Political Economy, 2014, vol. 36, issue C, 71-88

Abstract: There exists a persistent disagreement in the literature over the effect of business cycles on economic growth. This paper offers a solution to this disagreement, suggesting that volatility carries not only a positive direct effect, but also a negative indirect effect, operating through the insurance mechanism of government size. Theoretically, the net growth effect of volatility is then ambiguous. The paper reveals the underlying endogeneity of government size in a balanced panel of 90 countries from 1961 to 2010. In practice, the negative indirect channel dominates in democracies, but with less power to choose public services in autocratic regimes the positive direct effect takes over. Consequently, volatile growth rates are detrimental to growth in democracies, but beneficial to growth in autocracies. The empirical results suggest that a one standard deviation increase of volatility lowers growth by up to 0.52 percentage points in a democracy, but raises growth by 1.66 percentage points in a total autocracy. These findings point to a crucial intermediating role of governments in the relationship between volatility and growth. Both the size of the public sector and the regime form assume key roles.

Keywords: Economic growth; Volatility; Business cycles; Government size; Regime form (search for similar items in EconPapers)
JEL-codes: E32 H11 O43 P16 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Working Paper: Volatility and Growth: Governments are Key (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:poleco:v:36:y:2014:i:c:p:71-88

DOI: 10.1016/j.ejpoleco.2014.07.005

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