Aizenman, JoshuaPinto, BrianSushko, Vladyslav2012-03-192012-03-192011-10-01https://hdl.handle.net/10986/3626This paper examines how financial expansion and contraction cycles affect the broader economy through their impact on eight real economic sectors in a panel of 28 countries over 1960-2005, paying particular attention to large, or sharp, contractions and magnifying and mitigating factors. Overall, the construction sector is the most responsive to financial sector growth, with a number of others -- such as government, public utilities, and transportation -- also exhibiting significant sensitivity to lagged financial sector growth. Sharp fluctuations in the financial sector have asymmetric effects, with the majority of real sectors adversely affected by contractions but not helped by expansions. The adverse effects of financial contractions are transmitted almost exclusively by the financial openness channel with foreign reserves mitigating these effects with a sizeable (10 to 15 times greater) impact during sharp financial contractions. Both effects are magnified during particularly large financial contractions (with coefficients on interaction terms two to three times greater than when all contractions are considered). Consequent upon a financial contraction, the most severe real sector contractions occur in countries with high financial openness; relative predominance of construction, manufacturing, and wholesale and retail sectors; and low international reserves. Finally, the analysis finds that abrupt financial contractions are more likely to follow periods of accelerated growth, indicative of "up by the stairs, down by the elevator dynamics."CC BY 3.0 IGOABSOLUTE VALUEACCOUNTINGADVANCED ECONOMIESADVERSE EFFECTADVERSE EFFECTSADVERSE IMPACTAGGREGATE LEVELAGRICULTURAL SECTORAGRICULTUREANNUAL GROWTHANNUAL GROWTH RATEAVERAGE GROWTHAVERAGE GROWTH RATEAVERAGE LEVELBALANCE SHEETBANK POLICYBANKING CRISESBANKING CRISISBENCHMARKBOOM-BUST CYCLESBUFFERBUSINESS CYCLEBUSINESS CYCLESCAPITAL ACCOUNTCAPITAL ACCOUNT OPENNESSCAPITAL FLIGHTCAPITAL FLOWSCAPITAL INFLOWSCAPITAL MOBILITYCOLLATERALCOMPARATIVE ADVANTAGECONTROL VARIABLECONVERGENCE HYPOTHESISCORRELATION COEFFICIENTSCOUNTRY LEVELCREDIT MARKETSCROSS-BORDER CAPITALCUMULATIVE DISTRIBUTIONCUMULATIVE DISTRIBUTION FUNCTIONCURRENCYCURRENCY CRISESCURRENCY CRISISDEBTDEFICITSDEFLATIONDEPENDENT VARIABLEDEVELOPED COUNTRIESDEVELOPING COUNTRIESDEVELOPMENT ECONOMICSDEVELOPMENT INDICATORSDEVELOPMENT POLICYDIMINISHING RETURNSDOMESTIC DEMANDDUMMY VARIABLESECONOMIC CONTRACTIONSECONOMIC CRISISECONOMIC DOWNTURNSECONOMIC GROWTHECONOMIC IMPACTECONOMIC LITERATUREECONOMIC SECTORSECONOMICS LETTERSEMERGING MARKETEMERGING MARKET ECONOMIESEMERGING MARKETSEMPIRICAL ESTIMATESERROR TERMESTIMATION RESULTSEXOGENOUS VARIABLESEXPLANATORY VARIABLESEXPORTSEXPOSUREEXTERNAL FINANCEEXTERNAL FINANCINGFINANCIAL ASSETSFINANCIAL CAPITALFINANCIAL COLLATERALFINANCIAL CRISISFINANCIAL DEPTHFINANCIAL DEVELOPMENTFINANCIAL INTEGRATIONFINANCIAL INTERMEDIATIONFINANCIAL MANAGEMENTFINANCIAL OPENNESSFINANCIAL SECTORFINANCIAL SECTOR DEVELOPMENTFINANCIAL SHOCKFINANCIAL SHOCKSFINANCIAL STABILITYFINANCIAL STRESSFINANCIAL STUDIESFINANCIAL SYSTEMFINANCIAL SYSTEMSFINANCIALLY OPEN ECONOMIESFIXED EFFECTSFOREIGN ASSETSFOREIGN CAPITALFOREIGN EXCHANGEFOREIGN EXCHANGE MARKETSFOREIGN EXCHANGE RESERVEFOREIGN EXCHANGE RESERVESFOREIGN RESERVESFUTURE RESEARCHGDPGDP PER CAPITAGLOBAL CURRENCYGLOBALIZATIONGOVERNANCE INDICATORSGOVERNMENT EXPENDITURESGOVERNMENT SPENDINGGROWTH RATEGROWTH RATESGROWTH THEORYHOLDINGIMPORTSINCOMEINFLATIONINFLATION RATESINSURANCEINTERNATIONAL BANKINTERNATIONAL ECONOMICSINTERNATIONAL RESERVESINVESTMENT PROJECTSLAGGED GROWTHLAGGED VALUELIBERALIZATIONLIQUIDITYLIQUIDITY CRUNCHLONG-RUN GROWTHMACROECONOMICSMARGINAL EFFECTMARGINAL RETURNSMARKET LIQUIDITYMARKET VALUESMEAN GROWTHMONETARY FUNDMORAL HAZARDMORTGAGEMORTGAGE LOANSNEGATIVE EFFECTNEGATIVE IMPACTNEOCLASSICAL GROWTH MODELNORMAL DISTRIBUTIONNULL HYPOTHESISOPEN ECONOMIESOUTPUTOUTPUT COLLAPSESOUTPUT LOSSPANEL REGRESSIONSPOLICY OPTIONSPOLICY RESEARCHPOLITICAL STABILITYPOLITICAL TURMOILPOVERTY REDUCTIONPRIVATE CAPITALPRIVATE CAPITAL FLOWPRIVATE CAPITAL FLOWSPRIVATE INVESTMENTPRODUCTIVITY GROWTHPUBLIC GOODPUBLIC INVESTMENTPUBLIC UTILITIESRAPID EXPANSIONREAL ESTATEREAL GDPREAL GROWTH RATEREAL INTERESTREAL INTEREST RATEREAL INTEREST RATESRECESSIONREGRESSION ANALYSISREGULATORY REFORMRELATIVE WEIGHTSRESERVE ACCUMULATIONRESERVE CURRENCYRESERVE HOLDINGSROBUSTNESS CHECKRULE OF LAWSERIAL CORRELATIONSOCIAL COSTSSTABLE ECONOMIC GROWTHSTATISTICAL ANALYSISSTRUCTURAL BREAKSTRUCTURAL CHANGETRADE OPENNESSVALUE ADDEDWEALTHWORLD DEVELOPMENT INDICATORSWorld Bank10.1596/1813-9450-5860