FINANCIAL INTEGRATION AND MACROECONOMIC VOLATILITY: NEW EVIDENCE FROM DSGE MODELING

Abstract

This paper provides a brief overview of theoretical and empirical literature on financial integration and macroeconomic volatility nexus highlighting how the degree of financial integration affects the volatility of macroeconomic fundamentals. Using a dynamic stochastic general equilibrium (DSGE) model, our findings show that: (i) higher degree of financial integration tends to decrease short-run volatility; (ii) following monetary policy shocks, financial integration increases nominal exchange rate and output volatility and reduces both nominal and real interest rates and consumption volatility; and (iii) in response to fiscal shocks, financial integration stabilizes all variables under the assumption of perfect capital mobility.