How Does Stability in Financial Openness Affect Growth?

In the growth process, financing is needed to fulfill the potential for growth. If there is an insufficiency, the potential is said to be underutilized. It is suggested that financial openness prevents the congestion when the real side of the economy is in need of finance. Therefore, the relief in accessing finance, in an indirect way, can contribute to economic growth. Recently, there has been a growing literature analyzing whether the financial side has an impact on the real side of the economy. Within the financial side, a special attention is paid to international capital flows and whether they can have impact on economic growth. Some channels are described within the theory originating from financial openness to economic growth. However, there is a controversy for the causal link. Moreover, the link is criticized in the way that financial openness brings about exchange rate instability which further leads to destabilization in the real sector (Dornbusch, 1976). This study attempts to focus on domestically stable financial openness by considering financial openness and exchange rate stability together. Direct and indirect mechanisms are introduced. According to this, a new index is constructed to proxy stable financial openness via including portfolio investment plus exchange rate volatility. The new dataset is employed to analyze whether a domestically stable financial openness is able to affect the real side of the economy positively.