The rapid expansion of organized equity exchanges in both emerging and developed markets has prompted policymakers to raise important questions about their macroeconomic impact, yet the need to focus on recent data poses implementation difficulties for econometric studies of dynamic interactions between stock markets and economic performance in individual countries. This paper overcomes some of these difficulties by applying recent developments in the analysis of panels with a small time dimension to estimate vector autoregressions for a set of 47 countries with annual data for 1980–1995. After describing recent theories on the role of stock markets in growth and considering a pure cross-sectional empirical approach, our panel VARs show leading roles for stock market liquidity and the intensity of activity in traditional financial intermediaries on per capita output. The findings underscore the potential gains associated with developing deep and liquid financial markets in an increasingly global economy.

Utilizing a bank-lending channel framework, we investigate the effects of expansionary and contractionary policy separately on the loan behavior of low-capital and high-capital banks, and between pre-Basel/FDICIA and post-Basel/FDICIA periods. Our results show that low-capital banks are adversely affected by contractionary policy. Expansionary policy, however, is not effective in stimulating the loan growth of low-capital banks. These results are consistent with lending channel predictions, but only hold in the post-Basel/FDICIA period when the capital constraint is stringent relative to the pre-Basel/FDICIA period. These asymmetric policy results have implications for the interaction of monetary and capital regulatory policies.