Abstract
This paper investigates the relationship between trust and macroeconomic volatility. An illustrative model rationalizes the relationship between trust and volatility. In this model, trust relaxes credit constraints and diminishes investment’s procyclicality. I provide empirical evidence for the basic predictions of the model. Then, I show that higher trust is associated with lower macroeconomic volatility in a cross section of countries. This relationship persists when various covariates are taken into account. I use inherited trust of Americans as an instrumental variable for trust in their origin country to overcome reverse causality concerns. Using changes in inherited trust over the 20th century, I do not find clear evidence that increasing trust is also associated with decreasing volatility across time at the country level.
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