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 matur-ity 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. JEL codes: E44, G30, O16. After the financial crises of the 1990s many voices rose to explain that the causes of these crises were new (Radelet and Sachs 1998; Corsetti, Pesenti, and Roubini 1999). Indeed, the usual features known to trigger crises (unsustain-able government economic policies; Krugman 1979) were absent or could not by themselves imply such severe crises (Baig and Goldfajn 2002). Instead, new phenomena were in play, such as the large short-term debt that firms had accu-mulated before the crisis (table 1)