Finance, Volatility, and Growth

Lukas Schmid, Howard Kung and Alexandre Corhay
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Lukas Schmid: Duke University
Howard Kung: London Business School
Alexandre Corhay: University of British Columbia, Sauder School of Business

No 1536, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: Is there a fundamental link between macroeconomic risk and growth? Is there a causal link between finance and growth? These questions are central for the design of stabilization policies and for welfare. How- ever, no consensus has yet emerged in the literature. We contribute to that debate by developing a general equilibrium stochastic endogenous growth model that allows to examine the impact of financial frictions on volatility and growth. In the model, growth is driven by the endogenous accumulation of physical and intangible capital, both of which are subject to distinct financial frictions. We characterize the conditions under which finance and volatility foster growth. We find that in the presence of relatively mild financial frictions, alleviating financial constraints leads to both higher average as well as more volatile growth rates, so that a trade-off between volatility and growth emerges. When financial frictions primarily affect physical capital accumulation, the ensuing cycles occur at business cycle frequency. On the other hand, frictions to intangible capital accumulation imply amplified low-frequency movements. The welfare implications depend on preferences: with recursive preferences, low-frequency volatility is very costly

Date: 2015
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-mac
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