Financial Volatility, Macroprudential Regulation and Economic Growth in Low-Income Countries

Lead Research Organisation: University of Manchester
Department Name: Social Sciences

Abstract

The aim of the project is to study interactions between financial volatility, macroprudential regulation, and economic growth, in the context of low-income developing countries. The project will tackle these issues both analytically and empirically through the construction of theoretical macroeconomic models, the application of econometric techniques, and the preparation of country case studies, with the aim of drawing broad policy lessons for the design of macroprudential rules. The lessons from these contributions (in all, six theoretical and econometric papers, and two country case studies) will be summarized in three policy briefs, which will be circulated to a wider, non-academic audience.

In its two theoretical contributions, the project will study (i) how "robust" prudential rules are, in a weak institutional environment, in their ability to mitigate financial volatility, taking into account their impact on borrowing costs, private capital accumulation, and growth, and (ii) the channels through which the lack of predictability in project aid disbursements may affect the capacity of recipient governments to formulate medium-term spending plans to spur growth. Both contributions will be based on stochastic endogenous growth models with financial intermediation and credit market imperfections.

In its four empirical contributions, the project will deal with (i) the impact of financial regulation on financial volatility and its subsequent role in promoting economic growth, by mitigating the degree of volatility, (ii) the impact of aid and its volatility, along with that of remittances, on growth and poverty, (iii) the role of capital movements on both the level and the instability of the real exchange rate, as well as the implications of these movements for economic growth, and (iv) the impact of information sharing (credit registries and credit bureaus) on the structure of credit in Sub-Saharan Africa, a region where financial development is still weak. All empirical studies will use state-of-the-art dynamic panel data estimation techniques that address issues of endogeneity and reverse causality, prominent in this literature. The studies will make use of the largest possible set of countries and years, with particular attention to the sources of information regarding the regulatory and supervisory practices across banking systems.

The project will also develop two case studies, both of which focusing on French-speaking Sub-Saharan Africa. The purpose of the first study is to assess the relevance, the easiness to implement, and the expected effectiveness of a macroprudential framework for the WAEMU region, while the second study will be related to the second empirical component of the project where four cases will be identified under the condition that the aid (or remittances) to GDP ratio is (i) counter-cyclical and destabilizing, (ii) counter-cyclical and stabilizing, (iii) pro-cyclical and destabilizing, and (iv) pro-cyclical and stabilizing.

The material developed in the above-cited contributions will serve as a basis for the preparation of three policy briefs, which will draw together the implications of (i) the various papers for the type of macroprudential tools that are appropriate for promoting growth in Sub-Saharan Africa, (ii) the analysis for the speed, and nature, of international financial integration for Sub-Saharan African countries, and (iii) the second case study.

Dissemination will involve presentations to both academic and policy-oriented audiences, including national and international institutions involved in development. Two major conferences (one in France, the other in Senegal) will be organized during the course of the project. A particular effort will be made for dissemination in Francophone Sub-Saharan Africa, where policymakers are likely to benefit directly from the lessons drawn from the project.

Planned Impact

The project's main objective is to contribute to the economic growth progress of Sub-Saharan Africa by drawing policy lessons for the design of macroprudential rules aimed at mitigating the impact of financial volatility on economic growth. Although much of the debate has focused on the implications of financial volatility for short-term economic stability, the emphasis of our research is on the long-term effects of such volatility. From that perspective, the global financial crisis raises some important issues. How does financial volatility affect long-run growth? Can macroprudential rules designed to reduce the procyclicality of financial systems be detrimental to long-run growth? Is there a need to revisit the pace of domestic financial liberalization? These issues are particularly important for the poorest countries, given the need to maintain high growth rates to reduce poverty and promote human development.

By its very design, the project involves international partnerships and capacity building. The PI and one of the CIs are from the University of Manchester, while the remaining twelve CIs include specialists in the field of development from leading institutions in France and Senegal and from the IMF, the Director of the Centre Ouest Africain de Formation et d'Etudes Bancaires (COFEB) at the Central Bank of Western African States (Senegal), and the Manager of the Research Division at the African Development Bank (AfDB). Both COFEB and the AfDB are important non-academic stakeholders with a keen interest in the issues to be addressed by the project. In addition, the institution where COFEB is based is an important potential end user of the policy lessons of the project.

Both of these African institutions have been involved in the design of the research agenda, and will contribute in important ways (as co-authors) in the implementation of the project's outputs.

Capacity building activities include:

- A mid-term stakeholder conference, to be held in October 2015 at FERDI in Clermont-Ferrand, France, to which co-investigators will attend, and invitations will be sent to institutions in Francophone Sub-Saharan Africa and international development institutions;
- A final conference, to be held in November 2016 at COFEB in Dakar, Senegal, and invitations will be send to institutions in Francophone Sub-Saharan Africa and international development institutions;
- Seminars, in which co-authors from partner institutions in Africa will be invited to present joint papers;
- Transfer of all datasets and relevant computer codes, both fully documented, upon completion of the project.

To facilitate diffusion of the project's outputs and increase the likelihood of their impact in providing lasting value to participants and the wider social science community, they will be posted on a dedicated page at the CGBCR with links to CERDI and FERDI. In addition, a blog will be created and managed to best engage the beneficiaries and offer further interaction opportunities. Ultimately, all research outputs will be submitted for publication in leading refereed journals.

One of the partners, BCEAO, will benefit directly from this research on financial sector issues in Francophone Sub-Saharan Africa. Its "sister" institution in the CFA franc zone, BEAC will also benefit. We intend to invite senior BEAC officials to the final conference in Dakar, where the research outputs will be presented. Because the policy briefs will make practical recommendations for the region, they will be directly relevant to all policymakers in the region.

International organizations like the AfDB, the IMF, and the World Bank will also be invited to participate at the Dakar conference. The policy recommendations of the project may prove useful to these institutions as well in shaping their advice on financial sector policies for the region.
 
Description Through its academic and policy contributions, as well as its case studies, the project has brought new insights (both theoretical and empirical) on the links in low-income countries--a group of countries where administrative capacity is limited and promoting growth is an essential goal of policymakers--between macroprudential regulation and economic growth, the volatility of financial flows and growth, and the design of macroprudential regimes.

What we have discovered is that for a project of this type, getting senior policymakers from key policy institutions on board early, at the very design stage, is essential to achieve impact. In particular, by collaborating from the start with senior staff from BCEAO (Central Bank of Western African States, the project's main partner in Sub-Saharan Africa), the project was immediately put in a position to influence directly policy decisions and outcomes.

In addition to policy impact, the project was also able to achieve conceptual impact. At the analytical level, one of the contributions of the project was the first to develop a formal framework to study the links between financial stability, macroprudential regulation, and economic growth. This is an important because much of the literature in recent years has focused on assessing how macroprudential financial regulation should be designed to reduce short-run procyclicality and mitigate the risk of financial crises. However, policies designed with those objectives in mind could well be detrimental to economic growth in the longer run, as a result of their adverse effect on risk taking and incentives to borrow and lend. In low-income countries, where sustaining high growth rates is essential to increase standards of living and escape poverty, understanding the terms of this trade-off is essential. The paper can be built upon or extended in a number of fruitful directions by other researchers.

To achieve impact, it is also important to maintain an active discussion (through blog entries) around the core papers and themes covered by the project. The blog saw the participation of many policy-oriented economists from all around the world---including some from major international institutions (e.g., the International Monetary Fund and the World Bank) involved in providing advice on financial regulation and economic growth to Sub-Saharan African countries.
Exploitation Route As noted above, one of the contributions of the project was the first to develop a formal framework to study the links between financial stability, macroprudential regulation, and economic growth--an issue that has received limited attention in the literature. The model developed in the paper can be built upon or extended in a number of fruitful directions by other researchers.

Based on the compilation of a new, integrated database on capital flows, macroprudential regimes, and other determinants of economic growth, the project's empirical contributions provided original ways of studying the impact of financial volatility and macroprudential regimes on growth in developing countries, as well as the determinants of financial fragility in these countries. It is expected that both the database and the methodology will be used and refined by other researchers.

The case study on WAEMU countries, whose policy recommendations are actively being discussed and implemented by BCEAO, are directly relevant to BCEAO's sister institution in the CFA franc zone in Central Africa, BEAC, and can be used also to implement regulatory reforms in that region. More generally, the report is also relevant for other low-income countries, in Africa and elsewhere, where administrative capacity is limited and the range of macroprudential regulation instruments is limited.

Finally, the integrated policy briefs, which put together the main policy lessons of the various contributions of the project on two main issues (Macroprudential Regulation for Promoting Growth in Low-Income Countries, and International Financial Integration, Financial Volatility and Growth, both of which available on the project's website) will also help policymakers in low-income countries in general to manage financial flows and mitigate financial instability though macroprudential regulation.
Sectors Government, Democracy and Justice

URL http://hummedia.manchester.ac.uk/schools/soss/cgbcr/esrc-dfid-project/ESRC-DFID%20Project%202014-17%20Completion%20Report.pdf
 
Description A major stakeholder in the region, BCEAO (one of the two central banks of the CFA franc zone), was involved in the project at the outset. Indeed, the Director of BCEAO's Financial Stability Department was directly involved in the project's design and scope. He was also a co-investigator, co-authoring one of the policy briefs produced by the project. Moreover, two other co-investigators are staff members of two important non-academic stakeholders in the region, the African Development Bank (AfDB) and International Monetary Fund (IMF). In particular, in the context of its surveillance mandate for its member countries, the Fund has a direct interest in the issues addressed by the project and their policy implications. These two co-investigators have helped to disseminate the project's contributions within their institution, thereby promoting impact. Dwelling on several outputs of the project, a detailed case study on the current macroprudential regime in the Western African Economic and Monetary Union (WAEMU, the group of countries covered by BCEAO), and ways to improve it (based in part on the research conducted in the context of the project) was prepared by project members in close collaboration with BCEAO staff. The study immediately caught the attention of the Authorities at the highest levels of the institution. Initial feedback from, and exchanges with, senior staff have confirmed that BCEAO intends to adopt many of the recommendations made in that study. Moreover, these recommendations are expected to be carefully examined by BCEAO's sister institution in the CFA franc zone in Central Africa, BEAC, and to lead to regulatory reforms in that region as well. In parallel, the policy lessons of the project have been circulated widely inside the AfDB and the IMF by the project's co-investigators. We expect these lessons to inform policy advice to the countries of the region by these institutions.
First Year Of Impact 2016
Sector Government, Democracy and Justice
Impact Types Economic

 
Description Project's Influence on policy in WAEMU region
Geographic Reach Africa 
Policy Influence Type Influenced training of practitioners or researchers
Impact A major stakeholder in the region, BCEAO (Central Bank of Western African States, one of the two central banks of the CFA franc zone), was involved in the project at the outset. The Director of BCEAO's Financial Stability Department was directly involved in the project's design and scope and was also a co-investigator. In addition to providing general expertise and feedback, he co-authored one of the policy briefs produced by the project. Project members, in close collaboration with BCEAO staff and dwelling on the research conducted in the context of the project, prepared a detailed case study on the current macroprudential regime in the Western African Economic and Monetary Union (WAEMU, the group of countries covered by BCEAO), and ways to improve it. The study immediately caught the attention of the Authorities at the highest levels of the institution. Initial feedback from, and exchanges with, senior staff have confirmed that BCEAO is in the process of adopting many of the recommendations made in the study. These recommendations are also expected to influence BCEAO's sister institution in the CFA franc zone in Central Africa, BEAC, and to lead to regulatory reforms in that region as well.
URL http://hummedia.manchester.ac.uk/schools/soss/cgbcr/esrc-dfid-project/ESRC-DFID%20Project%202014-17%...
 
Title Integrated database on capital flows, macroprudential regimes, and growth 
Description In the context of the project, two empirical papers collected extensive data on capital flows, macroprudential regimes, and other determinants of economic growth. These datasets are integrated, in the sense that the frequency and coverage of the underlying statistics (both over time and across countries) are fully integrated. This was en important endeavour because existing data on macroprudential regulation across countries were scattered in a number of publications, some of them unpublished. 
Type Of Material Database/Collection of data 
Year Produced 2016 
Provided To Others? Yes  
Impact The database was transferred to staff from BCEAO (the project's main partner in Sub-Saharan Africa), namely those working in the Financial Stability Department and Research Department of the institution. At the same time, formal training on the econometric methods used in the context of the project was provided to them just before the project's closing conference. We expect BCEAO staff to exploit the data extensively in the coming months. 
URL http://hummedia.manchester.ac.uk/schools/soss/cgbcr/discussionpapers/dpcgbcr215.pdf
 
Description Project's regional conference 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Policymakers/politicians
Results and Impact The project's closing conference took place on November 9th, 2016, in Dakar Senegal. The conference was hosted by BCEAO (the Central Bank of Western African States), one of the main stakeholders in the area of macroprudential regulation in Western Africa and a project's partner. The conference was attended by more than 60 people, including Staff from BCEAO's Research Department and Financial Stability Department, as well as staff from BEAC (Bank of Central African States, BCEAO's sister institution in the CFA franc zone), the African Development Bank, the International Monetary Fund, the World Bank, and academics from the region.
Year(s) Of Engagement Activity 2016
URL http://www.socialsciences.manchester.ac.uk/cgbcr/research/escr-dfid-project/flagship-conference/