Financial Inclusion, Financial Depth, and Macroeconomic Fluctuations

Abstract

The study bridges the gap between growth and business cycle literature by addressing two critical issues related to the connection between financial development (FD) and macroeconomic fluctuations (MF). First, it explores strategies for achieving FD in an emerging economy. Second, it examines the extent to which FD can occur while maintaining system stability. To address the first problem, the research evaluates the impact of two main components of FD, financial inclusion and financial depth, on fluctuation, while the second issue examines the impact of different degrees of financial inclusion and depth on macroeconomic volatility. The analysis is extended to consider the influence of demand and supply-side drivers of FD on MF. By introducing theoretical underpinnings of financial depth and access in a large-scale new Keynesian model, the study indicated that the financial sector with low depth and access intensifies fluctuations caused by all shocks, whether real, nominal, or financial. The study also found that for macroeconomic stability in the face of diverse shocks, a medium to high level of depth with a moderate degree of inclusion is essential. Furthermore, it is encouraged to reach a greater degree of FD using supply-side drivers rather than demand-side variables.