Financial Development and Macroeconomic Volatility

Using cross‐country panel data over the period 1996–2012, this paper examines the impact of financial development on macroeconomic volatility using GMM estimators. In contrast to the linear relationship identified in many previous studies, we present robust evidence suggesting that the effect of financial development on macroeconomic volatility is nonlinear and U‐shaped. We also investigate the potential differences between developed and developing countries. The results of the paper add new evidence and shed interesting insights into the recent debate on the role of finance in macroeconomic fluctuations.