Comments on “The Financial Accelerator, Globalization and

Output Growth Volatility” Bruno Ćorić, Geoff Pugh

by Saša Žiković

Motivation Considerable evidence that US GDP growth in early ‘80

became less volatile than in previous decades – “Great Moderation” process.

The paper builds upon the premise of similar behaviour around the world.

Authors ask a very interesting question – “Why did so many countries across the world experience reduced output volatility in the decades preceding the current global downturn?”

Investigation from a global perspective into the possibility that international diversification of economic agents’ net worth influenced the strength of the Financial Accelerator which, in turn, contributed to changes in GDP growth volatility.

The contribution of the present paper is to test this hypothesised explanation by econometric analysis of 85 countries over the period 1970 to 2004.

Motivation

The authors opt for the view that effect of changes in aggregate economic activity on net worth may have weakened the Financial Accelerator, thereby reducing output growth volatility.

First hypothesis (H1): International net worth diversification reduced output growth volatility.

The hypothesized mechanism depends on the assumption of asymmetric economic shocks across national economies; that is, of incomplete GDP growth synchronization.

Second hypothesis (H2): Moderating or stabilizing influence of net worth diversification may have been merely transient, as its capacity to stabilize the global economy was eventually undermined by the synchronizing effects of globalization

Good points of the paper

Very good written and potentially an important paper

Builds upon good theoretical and empirical basis

Relevant and up to date literature Uses adequate data and variables Robustness checks in place Econometrics are done carefully and every

detail is taken care of All around an excellent piece of work

Findings Negative coefficients on net worth diversification (NWD)

= increased international diversification of agents’ net worth connected to lower GDP growth volatility.

Positive coefficients on inflation volatility = higher monetary disturbance on average leads to higher GDP growth volatility.

Positive coefficients on trade openness = increase in international trade intensity is associated with higher growth volatility.

Results are robust with respect to a different definition of output growth volatility as well as to different estimation techniques, unlikely to be driven by endogeneity or spurious regression.

Findings?

The original question “...Why did so many countries across the world experience reduced output volatility...” is not answered!

Is this the case of authors’ failure to answer the question they start with or is the intro poorly written.

I trust it’s the second – rewrite the introduction since it is misleading the reader

What about causality – what is the cause and what is the effect?

Is NWD: 1) a piece of a puzzle that is causing the moderation or2) is it that the moderation is causing investors to

diversify and seek new opportunities?

Turning to financial accelerator hypothesis

The financial accelerator hypothesis says that credit market distortions magnify economic shocks.

Disturbances that would be small if markets were efficient are exaggerated and prolonged due to imperfections in credit and loan markets. Credit market distortions destabilize the economy.

The financial accelerator hypothesis is important because standard business cycle models require large, persistent disturbances to mimic the business cycles observed in the data.

Because the financial accelerator amplifies and propagates shocks, it can potentially explain why business cycles are so significant even though the observed shocks are not.

A word of warning

A problem related to the existing literature applies to the empirical evidence giving support to the financial accelerator hypothesis.

Most of these studies are either: 1) based on reduced form analysis not aimed at revealing

the causal structural interplay among the variables, or2) structural specifications not given support by data in

the sense of being misspecified.

Some recent examples: Lown and Morgan (2006), Swiston (2008) and Bayoumi and Melander (2008)

A word of warning

Misspecification - In the case of estimating simultaneous equation models that have been exactly identified through e.g. imposing a priori restrictions on their contemporary causal structure and assuming a diagonal structural covariance matrix, one risks ending up with models that do not adequately represent the causal structure of the data and thus induce a simultaneity bias in estimation through imposing an improper causal structure.

The reason for this is related to the fact that one never can test for the exactly identifying restrictions of a structural model.

Questions and suggestions The paper is successful at finding a significant factor

to “moderation” but its explanatory power is really low!

The paper identifies only a piece of a puzzle - that is why the original question cannot be answered!

Hypothesis 1 proven partially – we cannot be certain about the direction of causality?!

Hypothesis 2 – weak evidence, for a publishing purposes it would be better left for the time being.

Methodology standard and correct – I am worried a bit about oversmoothing.

The paper is measuring unconditional volatility! The authors could use ARCH models for modelling

conditional volatility, even EWMA would be better than SMA standard deviation.

Questions and suggestions Construction of NWD var: it is constructed to decrease

variance but the problem of doubling FDI remains! Example: A world is composed of only 2 countries. US

invests 5% of its FDI/GDP in China and vice versa. What is the amount of FDI in the world?

A L A L5% 5% 5% 5%

10% 10%

20% ?

FDI/GDP: 5%+ 5%10%

USA China

Questions and suggestions Policy implications are still left unclear – should some

action be taken? What should a country do? The paper should try to give a better insight into the

mechanism behind this relationship – why are the two thing moving in opposite directions!?

Is the “Great Moderation” a good thing?

If NO, why?If YES, for who?

Is it playing in favour of US and EU? Should they be worried about BRICK growth and closing of the gap!?

Sustainable development – the developing can never catch the developed

It would be interesting to single out BRICK countries to see the specific effects on them

Something to think about The main part of world “moderation” happened after

the two oil shocks – are these the crucial moments that shaped future GDP movement?

Slowing down in world trade in the wake of the industrial country recession – decrease in exports from less developed countries

Significant support is found for the positive link between bilateral trade intensity and business cycle comovement in a cross-section of industrialized country pairs (trade-comovement puzzle) - see Drozd, Nosal (2008)

Is this the financial accelerator or stabilizer equilibria we were seeing at work? – see House (2006)