Macroeconomic Volatility

Many developing countries, and especially the poorest ones, experience high macroeconomic volatility and frequent financial crises. Macroeconomic instability deters growth and entails major welfare costs—particularly severe for the poor, due to their limited asset buffers and inadequate access to risk diversification.

Research studies the nature of the shocks faced by different types of developing countries, and the contribution of policy and other forces (such as external shocks and other exogenous disturbances) to mitigate or exacerbate volatility. It assesses reforms to reduce the frequency and impact of disturbances. Among the questions addressed by the research are:

•  How does volatility affect growth, and how big is the impact? Is it driven mostly by rare “large” shocks, or by frequent small disturbances?
• What are the major sources of macroeconomic instability—exogenous external shocks, or self-inflicted policy mistakes?
• What is the scope for volatility-reducing macroeconomic policies, e.g., fiscal, public debt and exchange rate management? What is the contribution of microeconomic flexibility?
• What is the role of financial development for aggregate volatility? When does it facilitate the absorption of shocks, and when is it a source of macroeconomic fragility?
• How large is the welfare cost of aggregate volatility? What are the main determinants of its magnitude?