Economic resilience: Trade-offs between growth and economic fragility

Aida Caldera, Alain de Serres, Filippo Gori, Oliver Röhn 28 March 2017



Major global crises such as the 2008-09 episode are rare, but severe recessions have been quite frequent over the past four decades, often with a large cumulated cost in terms of foregone income and high unemployment. Figure 1 shows the incidence of different crisis types (banking, currency, or sovereign debt crises) and the frequency of severe recessions in OECD countries since 1970. Severe recessions are defined as episodes characterised by a peak-to-trough fall in GDP exceeding the median fall across the entire country-year sample. Crisis episodes are identified using various commonly used datasets (Babecky et al. 2012, Reinhart and Rogoff 2013, Laeven and Valencia 2012).  

Figure 1 Crises and serious recessions have been frequent 

Number of countries

Note: The figure refers to crisis and severe recession episodes for 35 OECD countries over the period 1970Q1-2010Q4. Crisis episodes are from Babecky et al (2012).
Source: OECD calculations based on Babecky et al. (2012) data and Hermansen and Röhn (2015) for severe recessions.

Of all the episodes in Figure 1, the 2008-09 crisis was by far the most widespread and costly. From the beginning of the Great Recession, the cumulative output loss in the vast majority of countries exceeded the cost of previous post-1970 crises, with a large number of advanced economies suffering losses greater than 10% of GDP.

Effects of policies on growth and fragility 

These dramatic figures make a strong case for the implementation of measures to minimise the risk of such events. This raises the question of what policymakers can do to persistently enhance resilience in the face of economic and financial risks. However, in looking for answers, policymakers need to be mindful of the potential long-term growth impact of risk-mitigating measures. In other words, the benefits need to be balanced against the potential costs in terms of lower growth that some of the actions to reduce vulnerabilities to bad events could entail. Insofar as the risk-mitigating measures can involve a trade-off between growth and crisis risk, combinations of policies that avoid or ease the trade-off need to be identified. Our recent work has examined this issue from two different angles (summarised in Caldera et al. 2016).

The first angle focuses on the medium run, disentangling the effect of pro-growth policies on growth and the probability of a financial crisis over the subsequent five-year period. Our analysis in Caldera-Sánchez and Gori (2016) uses a methodology proposed by Rancière et. al (2006) and Razin and Rubinstein (2006) to examine the impact of a wide range of policy settings on three types of financial crisis episodes: currency crises, systemic banking crises, and episodes where both types of crisis hit a country (referred to as ‘twin crises’). The policy areas covered include financial market liberalisation, capital account openness, trade openness, exchange rate policy, and product market regulation.

The second angle, detailed in Caldera-Sánchez and Röhn (2016), consists of looking at the determinants of extreme negative economic outcomes (so-called tail risk) and at policies able to mitigate them. Negative tail risks are measured with respect to the (annual or quarterly) growth rates of the economy and are defined as the lower 10th percentile of the distribution for GDP growth. Therefore, the results provide an assessment of the effects of a set of policies on the maximum GDP loss (negative growth) that the economy can suffer with a given probability (90%), a measure referred to as GDP-at-risk.

What does the evidence suggest?

The results from our work, summarised in Figure 2, show that the growth-fragility nexus varies significantly according to broad policy areas.

  • Labour and product market policy settings that are conducive to higher productivity (e.g. through stronger competition) and/or employment have a positive effect on growth but generally little or no impact on crisis risk. They are thus located along the positive segment of the horizontal axis. The few exceptions include stronger active labour market programmes, which result in both higher average growth and less extreme negative tail risks, and lower import tariffs, which lowers crisis risk while having a favourable impact on average growth.
  • Indicators of institutional quality are associated with both higher growth and lower fragility (upper-left quadrant). These findings confirm that having in place a sound legal and judicial infrastructure (i.e. one that guarantees the enforcement of private contracts), provides adequate protection of property rights, and promotes arm’s-length transactions, is good for both growth and economic resilience. These results are consistent with the substantial literature suggesting that countries with better institutions are likely to suffer lower volatility and less severe output collapses (Acemoglu et al. 2003, Rodrik 1998).         

Figure 2. Policy areas in a growth-fragility framework

Note: Structural policies should be assessed on the basis of their effect on growth and economic fragility. In this chart, the effect of policies on economic fragility is plotted on the horizontal axis, the effect on growth is shown on the vertical axis. Fragility is defined as a higher likelihood of financial crises (banking, currency, or twin crisis) or a higher GDP (negative) tail risk. Different risk-growth patterns emerge for each policy area considered—pro-growth labour and product market policies improve economic performance without substantially affecting economic fragility. Better quality of institutions both increases growth and reduces economic fragility. However, macroprudential and financial market polices entail a growth-risk trade-off—the former decrease economic risk to the detriment of a higher growth rate, the latter promote growth but also increase financial risk.
Source: Caldera Sánchez et al. (2016).

However, trade-offs between growth and economic fragility arise in the case of financial market policies and macroprudential measures:

  • Market-oriented domestic financial reforms and higher capital account openness (what we call financial market policies) improve growth but, at the same time, increase the risk of financial crises (top-right quadrant). Evidence therefore suggests that financial liberalisation results in improved efficiency and a better allocation of financial capital. However the efficiency channel of financial market deregulation is paired with an increase in systemic financial fragility, as liberalisation episodes are sometimes linked to excessive credit growth and to boom-bust cycles in asset prices. These results are consistent with recent literature warning about the risk of excessive financial extension (Cournède and Denk 2015, Cecchetti and Kharroubi 2012, Arcand et al. 2015).
  • Macroprudential measures, instead, tend to reduce economic fragility but to the detriment of economic performance (bottom-left quadrant).1 Indeed, greater use of prudential policies is associated with fewer occurrences of severe recessions. At the same time, the findings indicate that several of these measures may come at a cost in terms of lower average growth.

Authors’ note: The opinions expressed in this column are those of the authors and do not necessarily reflect the views of the OECD.  


Acemoglu, D, S Johnson, J Robinson and Y Thaicharoen (2003) “Institutional causes, macroeconomic symptoms: Volatility, crises and growth”, Journal of Monetary Economics, 50: 49–123.

Arcand, J L, E Berkes and U Panizza (2015) “Too much finance?”, Journal of Economic Growth, 20(2): 105-148.

Babecký, J et al (2012) “Banking, debt and currency crises: Early warning indicators for developed countries”, ECB, Working Paper Series No 1485.

Caldera Sánchez, A, A de Serres, F Gori, M Hermansen and O Röhn (2016) "Strengthening economic resilience: Insights from the post-1970 record of severe recessions and financial crises economic policy paper", OECD Economic Policy Papers, December, No 20.

Caldera-Sánchez , A and F Gori (2016) “Can reforms promoting growth increase financial fragility? An empirical assessment”, OECD, Economics Department Working Papers, No 1340, OECD Publishing, Paris.

Caldera-Sánchez, A and O Röhn (2016) “How do policies influence GDP tail risks?”, OECD, Economics Department Working Papers, No 1339, OECD Publishing, Paris.

Cecchetti, S G and E Kharroubi (2012) “Reassessing the impact of finance on growth”,  Bank for International Settlements, Working Papers No 381.

Cerutti, E, S Claessens and L Laeven (2015) “The use and effectiveness of macroprudential policies: New evidence”, IMF, Working Paper No 15/61.

Cournède, B and O Denk (2015) "Finance and economic growth in OECD and G20 countries", OECD, Economics Department Working Papers, No 1223, OECD Publishing, Paris.

Hermansen, M and O Röhn (2016) “Economic resilience: The usefulness of early warning indicators in OECD Countries”, OECD Journal: Economic Studies, Vol 2016, forthcoming.

Laeven, L and F Valencia (2008), “Systemic banking crises: A new database”, IMF, Working Papers No WP/08/224.

Rancière, R, A Tornell and F Westermann (2006) “Decomposing the effects of financial liberalization: Crises vs growth”, Journal of Banking and Finance, 30(12): 3331-3348.

Razin, A and Y Rubinstein (2006) “Evaluation of currency regimes: The unique role of sudden stops”, Economic Policy, 21(45): 120-152.

Reinhart, C M and K S Rogoff (2013) “Banking crises: An equal opportunity menace”, Journal of Banking and Finance, 7(11): 4557-4573.

Rodrik, D (1998) “Who needs capital-account convertibility?”, Essays in International Finance, 55-65.


[1] We group in this category macro-prudential policies strictly speaking, and international reserves. Macro-prudential variables are from Cerutti et al (2015). These comprise bank debt-to-income ratios, an indicator of tax on financial institutions, required capital surcharges on systemically important financial institutions (SIFIs), limits to foreign currency loans, an index of borrower targeted instruments (including constraints on households debt to income ratio and caps based on loan-to-value ratios for new loans) and an overall macroprudential index.    



Topics:  Global crisis Macroeconomic policy

Tags:  economic resilience, growth, fragility, Macroprudential policy, labour market policies, economic risk, OECD, financial crises

Senior Economist in the Economics Department, OECD

Head of Structural Policies Surveillance Division, OECD

Economist, OECD

Economist in the Economics Department, OECD