Mitigating economic volatility: When building efficient financial markets should supersede conventional economic policy

Abstract

The choice of instruments for mitigating economic volatility is a serious consideration for policymakers and important question in government and economics. Using a DSGE model with endogenous technology creation, we show that efficient financial markets are more effective than conventional economic policies, such as fiscal interventions, in reducing economic volatility. Our findings are consistent with data from the Chinese and the US economies who contrast in structure perfectly for the purpose of our comparison. The implication is that rather than focusing on conventional economic policies, a government should help establish efficient financial markets to allow producers a hedge into equity finance during times of financial stress.