Financial Access and Consumption Smoothing

Does improving access to financial institutions always facilitate aggregate consumption smoothing? I document new empirical evidence that emerging economies with better access to banks are worse at consumption smoothing, whereas developed economies with better access to banks are better at consumption smoothing. This result is robust to alternative measures of domestic and international financial access and controlling for level of income. A simple one-good small open economy model supplemented with trend shocks and financial access heterogeneity is calibrated to match business cycle moments of developed and emerging markets. The model can qualitatively account for the change in the ratio of consumption volatility to income volatility to financial access for both developed and emerging economies, as seen in the data. A two-sector extension of the model captures the non-targeted business cycle moments too.