Financial volatility and economic growth, 1870-2016

We investigate the causal impact of financial risk on economic growth, using a panel spanning 150 years and 74 countries. Persistent low risk encourages risky investments that ultimately augment growth but at the cost of building up of vulnerabilities in the economy and thus has a boom-to-bust effect on growth: an initial increase followed by a reversal in two years. Persistent global low risk has a more pronounced effect on growth than local risk, highlighting the relative importance of the global risk environment. While the U.S. financial markets are important, their effects on risk appetite globally are still limited. The impact of low risk is the strongest after the Bretton Woods era, for developing countries, and for countries experiencing high credit growth. Finally, long-lasting low volatility affects growth amid its notable impact on capital flows, investment, and lending quality.