Investigating Financial Instability in a Dynamic Model: A Case Study of Middle Eastern Countries

Financial instability can lead to failure in financial markets and create macroeconomic costs. Therefore, by examining this harmful event, we can achieve conditions of economic stability and security. The main purpose of this study is to investigate the financial instability of Middle Eastern countries during the years 2000 to 2019 in a dynamic model and using a two-stage system of Generalized Method of Moments (GMM). To reach this goal, the index of instability and financial development was created on the basis of the influential variables of the banking sector and the stock market in two groups of oil exporting and non-exporting countries in the region. The estimation results show the different effects of variables on financial instability in exporting and non-exporting countries. Most countries in the region are oil exporters and the results of the estimate confirm the negative and significant impact of financial development and economic growth on financial instability. Also, in order to create a more comprehensive view, the control variables of the terms of trade, government spending and inflation have been used in the model. The first lag of financial instability and inflation variable have positive and significant effects and the terms of trade and government spending have negative and significant effects on financial instability. In oil non-exporting countries, due to less financial instability than exporting countries, the relationship between a number of variables and financial instability was not significant and different results were obtained. It is recommended that policy makers reduce financial instability by controlling prices and directing liquidity and credits to production, reforming the level and composition of government spending, and improving trade relations.