Macroeconomic Volatility and Economic Development

Abstract

In recent years the economic costs imposed by a volatile macroeconomic environment have come into increasingly clear focus. Recent research suggests that a volatile macroeconomic environment leads to significantly lower rates of investment and economic growth, undermines educational attainment, harms the distribution of income, and increases poverty. While the precise magnitude of these costs and the mechanisms through which they occur should, and undoubtedly will, remain the focus of further research for some time, the evidence is, in our view, compelling enough to justify research efforts directed at understanding why developing economies are so volatile, and what can be done to reduce the costs of this volatility. In this chapter we synthesize several lines of research that have been under way in the Inter-American Development Bank (IADB) on these questions. While none of these research projects has as its explicit focus the role of institutional factors in economic development, taken together we think they provide a preliminary but nevertheless significant message on linkages between governmental institutions, macroeconomic stability, and economic development.

This chapter has benefited from comments received at the IEA conference, particularly from Robert Bates. Some of our research has appeared in a chapter of Hausmann and Reisen (1996), and other portions in Inter-American Development Bank (1995). We are grateful to the OECD and the Inter-American Development Bank for granting permission to reproduce these portions.