DP9338 Finance, Governments, and Trade

Author(s): Giuseppe Bertola, Anna Lo Prete
Publication Date: February 2013
Keyword(s): financial reforms, government size, openness, private credit
JEL(s): E60, F13, G18
Programme Areas: International Macroeconomics, Public Economics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9338

We study how financial transactions may respond to exogenous variation in trade opportunities not only directly, but also through policy channels. In more open economies, governments may find it more difficult to fund and enforce public policies that substitute private financial transactions, and more appealing to deregulate financial markets. We propose a simple theoretical model of such policy-mediated relationships between trade and financial development. Empirically, we document in a country panel dataset that, before the 2007-08 crisis, financial market volumes were robustly and negatively related to the share of government consumption in GDP in regressions that also include indicators of financial regulation and trade openness, and we seek support for a causal interpretation of this result in instrumental variable specifications.