Abstract
Problem statement: This study investigated the relationship between c redit market development and economic growth for Greece for the period 1979-2007 using a Vector Error Correction Model (VECM). Questions were raised whether economic growth spurs credit market development taking into account the negative effect of inflation rate on credit market development. This study aimed to investigate the short-run and t he long-run relationship between bank lending, gross domestic product and inflation rate applying the Johansen cointegration analysis. Approach: To achieve this objective classical and panel unit roo t tests were carried out for all time series data i n their levels and their first differences. Johansen cointe gration analysis was applied to examine whether the variables are cointegrated of the same order taking into account the maximum eigenvalues and trace statistics tests. Finally, a vector error correctio n model was selected to investigate the long-run relationship between economic growth and credit market development. Results: A short-run increase of economic growth per 1% induces an increase of bank lending 2.2%, while an increase of inflation rate per 1% induces a relative decrease of bank len ding per 5.6% in Greece. The estimated coefficient of error correction term is statistically significa nt and has a negative sign, which confirms that the re is not any problem in the long-run equilibrium between the examined variables. Conclusion: The empirical results indicated that there is a long-ru n relationship between economic growth and credit market development for Greece.
Highlights
The relationship between economic growth and financial development has been an extensive subject of empirical research
The observed t-statistics fail to reject the null hypothesis of the presence of a unit root for all variables in their levels confirming that they are nonstationary at 1, 5 and 10% levels of significance the results of the PP, KPSS, LLC IPS and Breitung (1999) denoted as (BR) tests show that all variables are stationary of the same order when they are transformed into their second differences (Table 1a-1b)
The dynamic specification of the model allows the deletion of the insignificant variables, while the error correction term is retained by the estimation of the co-intergrated vector
Summary
The relationship between economic growth and financial development has been an extensive subject of empirical research. The main objective of this study was to investigate the relationship between economic growth and credit market development taking into account the effect of inflation rate on credit market development. Economic growth favors credit market development at times of low inflation rates. It has largely overlooked the possibility that endogenous constraints in the credit market, such as imperfect information, could be a significant obstacle to efficient credit allocation even when assuming that banks are free from interest rate ceilings. The expected return of the borrowers is an increasing function of the riskiness of their projects, the higher the risk the higher the return. This fact would discourage less risky investments from taking place, they could be more productive (selection effect). Safe borrowers, which deal with banks only, will be left with no other choice
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