Financial Volatility, Macroprudential Regulation and Economic Growth in Low-Income Countries

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Research Council Grant [RCG]


The aim of the project is to study interactions between financial volatility, macroprudential regulation, and economic growth, in the context of low-income developing countries. The project will tackle these issues both analytically and empirically through the construction of theoretical macroeconomic models, the application of econometric techniques, and the preparation of country case studies, with the aim of drawing broad policy lessons for the design of macroprudential rules.
The lessons from these contributions (in all, six theoretical and econometric papers, and two country case studies) will be summarized in three policy briefs, which will be circulated to a wider, non-academic audience.

In its two theoretical contributions, the project will study (i) how "robust" prudential rules are, in a weak institutional environment, in their ability to mitigate financial volatility, taking into account their impact on borrowing costs, private capital accumulation, and growth, and (ii) the channels through which the lack of predictability in project aid disbursements may affect the capacity of recipient governments to formulate medium-term spending plans to spur growth. Both contributions will be based on stochastic endogenous growth models with financial intermediation and credit market imperfections.

In its four empirical contributions, the project will deal with (i) the impact of financial regulation on financial volatility and its subsequent role in promoting economic growth, by mitigating the degree of volatility, (ii) the impact of aid and its volatility, along with that of remittances, on growth and poverty, (iii) the role of capital movements on both the level and the instability of the real exchange rate, as well as the implications of these movements for economic growth, and (iv) the impact of information sharing (credit registries and credit bureaus) on the structure of credit in Sub-Saharan Africa, a region where financial development is still weak. All empirical studies will use state-of-the-art dynamic panel data estimation techniques that address issues of endogeneity and reverse causality, prominent in this literature. The studies will make use of the largest possible set of countries and years, with particular attention to the sources of information regarding the regulatory and supervisory practices across banking systems.

The project will also develop two case studies, both of which focusing on French-speaking Sub-Saharan Africa. The purpose of the first study is to assess the relevance, the easiness to implement, and the expected effectiveness of a macroprudential framework for the WAEMU region, while the second study will be related to the second empirical component of the project where four cases will be identified under the condition that the aid (or remittances) to GDP ratio is (i) counter-cyclical and destabilizing, (ii) counter-cyclical and stabilizing, (iii) pro-cyclical and destabilizing, and (iv) procyclical
and stabilizing.

The material developed in the above-cited contributions will serve as a basis for the preparation of three policy briefs, which will draw together the implications of (i) the various papers for the type of macroprudential tools that are appropriate for promoting growth in Sub-Saharan Africa, (ii) the analysis for the speed, and nature, of international financial integration for Sub-Saharan African countries, and (iii) the second case study.

Dissemination will involve presentations to both academic and policy-oriented audiences, including national and international institutions involved in development. Two major conferences (one in France, the other in Senegal) will be organized during the course of the project. A particular effort will be made for dissemination in Francophone Sub-Saharan Africa, where policymakers are likely to benefit directly from the lessons drawn from the project.

Funded by the DFID ESRC Growth Research Programme
Short titleR:HSE HSE: ESRC DFID 2013
Effective start/end date1/07/1431/12/16

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