Vincent, BrunoHerrera, Santiago2012-05-302012-05-302008-05https://hdl.handle.net/10986/6692Recent estimates of the welfare cost of consumption volatility find that it is significant in developing nations, where it may reach an equivalent of reducing consumption by 10 percent per year. Hence, examining the determinants of consumption volatility is of utmost relevance. Based on cross-country data for the period 1960-2005, the paper explains consumption volatility using three sets of variables: one refers to the volatility of income and the persistence of income shocks; the second set of variables refers to policy volatility, considering the volatility of public spending and the size of government; while the third set captures the ability of agents to smooth shocks, and includes the depth of the domestic financial markets as well as the degree of integration to international capital markets. To allow for potential endogenous regressors, in particular the volatility of fiscal policy and the size of government, the system is estimated using the instrumental variables method. The results indicate that, besides income volatility, the variables with the largest and most robust impact on consumption volatility are government size and the volatility of public spending. Results also show that deeper and more stable domestic financial markets reduce the volatility of consumption, and that more integrated financial markets to the international capital markets are associated with lower volatility of consumption.CC BY 3.0 IGOAGGREGATE CONSUMPTIONANNUAL % GROWTHAVERAGE GROWTH RATEAVERAGE GROWTH RATESBASE YEARBENCHMARKSBUSINESS CYCLECAPITA GROWTHCAPITAL ACCOUNTCAPITAL ACCOUNT OPENNESSCAPITAL MARKETSCONSUMPTION EXPENDITURECONSUMPTION GROWTHCONSUMPTION SMOOTHINGCONSUMPTION SPENDINGCONSUMPTION VOLATILITYCONTROL VARIABLESCURRENCYDEPENDENCY RATIODEPENDENT VARIABLEDEVELOPING COUNTRIESDEVELOPMENT ECONOMICSDISCRETIONARY FISCAL POLICYDISCRETIONARY POLICYDOMESTIC FINANCIAL MARKETSDOMESTIC FINANCIAL SECTORECONOMIC FLUCTUATIONSECONOMIC GROWTHECONOMIC POLICYELASTICITYEQUITY MARKETEXPLANATORY VARIABLESEXPORTSEXTERNAL FINANCINGFEDERAL RESERVEFEDERAL RESERVE BANKFINANCIAL DEVELOPMENTFINANCIAL INTERMEDIARIESFINANCIAL LIBERALIZATIONFINANCIAL OPENNESSFINANCIAL SECTORFINANCIAL SECTOR DEVELOPMENTFINANCIAL VARIABLESFISCAL DISCIPLINEFISCAL POLICYFISCAL POSITIONFIXED EFFECTSFLUCTUATIONSGDPGDP DEFLATORGDP PER CAPITAGLOBAL ECONOMYGOVERNMENT CONSUMPTIONGOVERNMENT SPENDINGGROWTH RATESGROWTH VOLATILITYHIGH INCOMEHIGH-INCOME COUNTRIESHIGHER VOLATILITYHOUSEHOLD BUDGETSIMPORTSINCOMEINCOME TAXINCOMPLETE MARKETSINFLATIONINSTITUTIONAL ENVIRONMENTINSTRUMENTAL VARIABLEINSTRUMENTAL VARIABLESINTERACTION TERMINTERNATIONAL CAPITALINTERNATIONAL CAPITAL MARKETSINTERNATIONAL MONEYLABOR SUPPLYLATIN AMERICANLEVEL OF CONFIDENCELEVEL OF INCOMELIBERALIZATIONLOW INCOMELOW INCOME COUNTRIESMACROECONOMIC STABILITYMACROECONOMIC VOLATILITYMARKET INFORMATIONMIDDLE INCOMEMIDDLE-INCOME COUNTRIESMONETARY ECONOMICSOIL PRICESOPEN CAPITAL ACCOUNTOPEN ECONOMIESOPEN ECONOMYOUTPUTOUTPUT VOLATILITYPOLITICAL ECONOMYPOLITICAL SYSTEMPOLITICAL SYSTEMSPRIVATE CONSUMPTIONPUBLIC EXPENDITUREPUBLIC POLICYPUBLIC SPENDINGREAL GDPRISK AVERSERISK AVERSIONRISK PREMIUMSIDE EFFECTSSMOOTHING CONSUMPTIONSTANDARD DEVIATIONSTANDARD ERRORSSTEADY STATESUPPLY SIDESUPPLY-SIDETAXTAX RATETRADE VOLATILITYTRINIDAD AND TOBAGOUNCERTAINTYURBANIZATIONVOLATILITIESVOLATILITYWEALTHWorld Bank10.1596/1813-9450-4633