Financial Development and Growth Volatility: Time Series Evidence for Mexico and Usa

This paper presents time series evidence on the influences of financial deepening on growth and its volatility, in the cases of Mexico and USA. The paper attempts to contribute to the existing empirical literature in two relevant aspects. First, it focuses on two closely interconnected economies but quite different in terms of economic and financial development. Second, it uses time series methods to explicitly examine the relationship between financial development and growth volatility. It is found that, in the case of the USA, financial deepening is related to the rate of real output growth but finance does not show a significant relationship with growth volatility. In contrast, financial deepening seems to be pushed by economic growth in the case of Mexico. However, some evidence is found that financial deepening reduces growth volatility which, in turn, leads to higher output growth. Further, higher growth in USA results in higher growth in Mexico not only directly, a fact that is well known, but also through a reduction of Mexico’s growth volatility.