Crises, Volatility, and Growth

How do volatility and liquidity crises affect growth? When credit is constrained, a bias toward short-term debt can arise in financing long-term investments, generating maturity mismatches and leading potentially to liquidity crises. The frequency of liquidity crises ("abnormal" volatility) and the volatility of growth ("normal" volatility) are found to have independent negative effects on growth. Financial development however dampens the growth cost of volatility, but only in the case of normal volatility. The growth cost of volatility therefore depends critically on the composition of normal and abnormal volatility, the latter being more costly for growth. Copyright The Author 2007. Published by Oxford University Press on behalf of the International Bank for Reconstruction and Development / the world bank . All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org, Oxford University Press.