Openness and Macroeconomic Volatility: Do Development Factors Drive Such Ambiguous Results?

The 2008 financial crisis proved the “Great Moderation” (a period when it was believed that policymakers had successfully smoothed macroeconomic fluctuations) to be transitory. Understanding a country’s degree of susceptibility to these fluctuations is crucial to investors but previous studies have shown that increasing trade and financial openness can have ambiguous effects. This paper examines a set of 11 countries individually, before the financial crisis, modeling variability in output, consumption, and investment as functions of both openness and external volatility. Financial openness tends to reduce investment volatility for the countries in this sample, while consumption is relatively unaffected overall. Output variability registers mixed results. The regression results are then examined to find relationships with various economic, development, and institutional-quality indicators. Trade openness is found to be correlated with a reduction in output volatility for less-developed countries and an increase for developed countries, while financial openness shows the opposite outcome.