Research Insights: What Is the Role of State Capacity in Dealing with Macroeconomic Volatility?

Macroeconomic volatility can have serious implications for the economy; reducing a countrys exposure can increase long-term prosperity. When the government has significant capabilities, it is not necessary to isolate the economy using an inefficient technology: a large public sector that reduces the transmission of the shock in the economy. The effect of economic openness on government spending is mediated by the quality of government institutions. Countries must therefore invest in their capacities to face more effectively the challenges of external shocks. These capabilities are not developed overnight but instead result from continuous actions over time.