Working Paper: CEPR ID: DP9338
Authors: Giuseppe Bertola; Anna Lo Prete
Abstract: We study how financial transactions may respond to exogenous variation in trade opportunities not only directly, but also through policy channels. In more open economies, governments may find it more difficult to fund and enforce public policies that substitute private financial transactions, and more appealing to deregulate financial markets. We propose a simple theoretical model of such policy-mediated relationships between trade and financial development. Empirically, we document in a country panel dataset that, before the 2007-08 crisis, financial market volumes were robustly and negatively related to the share of government consumption in GDP in regressions that also include indicators of financial regulation and trade openness, and we seek support for a causal interpretation of this result in instrumental variable specifications.
Keywords: financial reforms; government size; openness; private credit
JEL Codes: E60; F13; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government consumption in GDP (E20) | financial market volumes (G15) |
| government consumption in GDP (E20) | financial market activity (G19) |
| government consumption in GDP (E20) | crowding-out effect in financial transactions (E44) |
| trade openness (F43) | financial market volumes (G15) |
| regulatory environment (G38) | financial market volumes (G15) |
| government retrenchment (H19) | financial market volumes increase from 1980 to 2007 (G15) |