Untangling the finance-growth nexus: The dual role of financial development in the transmission of shocks

Abstract

Does financial development shield countries from the pass-through of financial shocks to real outcomes? We evaluate this question by characterizing the probability density of GDP growth conditional on foreign and domestic financial stress indicators in a panel of 24 emerging countries. Our robust results unveil a previously unexplored dual impact of higher degrees of financial development on the transmission of financial stress: while the effect of global factors is attenuated, the impact of domestic factors is exacerbated. This result highlights a previously unexplored channel through which financial development can alter the link between financial (in)stability and GDP growth.