We study how financial development is related to short run stabilization. Specifically, our objective is to derive monetary policy efficiency measures (PEMs) for 37 industrialized and developing countries and analyze the impact that the size and depth of the banking sector and the capital sector have on policy performance. It is our contention that a more developed financial sector increases the scope of action of policy, resulting in improved policy performance. In our empirical analysis we use three financial development measures: private credit, liquid liabilities, and a financial aggregate index that comprises banking and stock market measures. Our findings suggest that more developed financial markets, controlling for central bank independence, and inflation targeting and membership to the Economic and European Monetary Union significantly contribute to explaining a more efficient monetary policy implementation.
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