CAUSAL LINK BETWEEN FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH: THE CASE OF TRANSITION COUNTRIES

Abstract

The financial market is an important element of any market economy. The study of the impact of financial development on the country’s economic growth is a very important and urgent topic. The financial sector plays a key role both in developed and developing countries. Financial markets play a critical role in the distribution of capital, financial intermediation, the transformation of available funds into investment, the distribution and diversification of risks. A well-functioning financial market increases productivity and significantly affects the country’s economic growth.The main objective of this study is to investigate the causal relationship between financial development, trade openness and economic growth. The empirical analysis of this study consists on panel data of 9 transition countries (Ukraine, Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova and Tajikistan) over the period 1998 to 2015. Inorder to investigate the causal link between financial development and economic growth a three-stage Panel Granger causality test was employed. Firstly stationarity properties of the series are examined with the help of Pesaran (2007) panel unit root test. Then Westerlund (2007) panel cointegration method is applied. In the final stage Panel Granger causality test is performed.The results obtained suggest that there is evidence of a bidirectional causality between financial development and economic growth in the short-run. Policy makers in transition countries should consider the impact of financial development on economic growth.