Recession and Financial Development: An Empirical Analysis

Abstract

We analyse the effects of financial development on recession while controlling for potential recession factors in 129 countries using data covering the 1990-2010 period. We mainly found a nonlinear and U-shaped relationship between recession and financial development with a threshold effect of 1.1528. 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. Moreover, fuels for South Asia (SASIA) and Latin America and Caribbean (LAC) countries and financial openness for sub-Saharan Africa (SSA) countries are negatively related to recessions; countries who manage their oil production in a good manner will also reduce the probability and impact of recessions. Thus, to fight against recession, SASIA and LAC countries should well manage oil production and usage while SSA countries may manage their financial openness. To the best of our knowledge, this is the first study examining this relationship using newly primary and hitherto almost unexploited “Rare macroeconomic disasters” data from Barro and Ursua (2012) which allow us to build a more specific proxy of the variable “economic recession”.