Financial Development, Financial Openness, and Policy Effectiveness

Abstract

This study explores how financial development and openness influence the effectiveness of fiscal and monetary policies. An analysis of data from about 100 countries between 1980 and 2018 reveals that both financial openness and development weaken the impact of monetary and fiscal policies. Our results further show that financial development in a country diminishes policy effectiveness depending on the country’s level of financial development; specifically, the more developed a country, the less effective the policies would be. Additionally, through a detailed examination employing a dynamic panel GMM approach, the study investigates the global repercussions of economic downturns in the US and how financial maturity shapes policy effectiveness during these times. We also discuss some policy implications that show that the positive impacts of monetary policy on output growth are lessened during crisis periods, and policymakers should act accordingly.