A new GLO Discussion Paper finds a U-shaped relationship between recession and financial development using panel data of 129 countries for 1990-2010.
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GLO Discussion Paper No. 555, 2020
On Recessive and Expansionary Impact of Financial Development: Empirical Evidence – Download PDF
by Nguena, Christian-Lambert & Kodila-Tedika, Oasis
GLO Fellow Christian Lambert Nguena
Author Abstract: This paper mainly examines the effect of financial development on the recession, while controlling for potential recession factors. Using panel data of 129 countries spanning 1990-2010, we implemented “Locally Weighted Scatterplot Smoothing”, “Local Linear” and “Iteratively Reweighted Least Squares” regression methods along with a Sasabuchi test to verify the inverse U-shape to estimate the extreme point for the non-linear specification. We mainly found a nonlinear and thus U-shaped relationship between recession and financial development with a threshold effect of 1.1528, which validate financial development recessive and expansionary real impacts. The financial development process presents an expansionary impact for countries with financial performance less than 1.1528, and countries with financial performance above the threshold of 1.1528 present a recessionary impact of financial development. Moreover, we found that trade openness contributes to increasing recession independently to the estimation method. Thus during economic crises of recession, policymakers should hold-on regional integration along with globalization doctrines. On the contrary, fuels for South Asia (SASIA) and Latin America and Caribbean (LAC) countries and financial openness for sub-Saharan Africa (SSA) countries impact negatively recessions; countries who manage their oil production in a good manner will also reduce the probability and impact of recessions, and appear to have an expansionary real impact only. Thus, to fight against recession, SASIA and LAC countries should well manage oil production and usage while SSA countries may manage their financial openness. Verifying the robustness permit us to confirm the baseline and extended model specification findings in terms of coefficients sign and significance; furthermore, to highlight SSA, SASIA and LAC as the order of continental/regional importance in increasing magnitude. Finally, the semiparametric regression shows that the results of the parametric part converge with the previous results in general, and bear out with illustration the functional form of the nonlinear relation between recession and financial development.
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