Does Supply-Leading Hypothesis Hold in Emerging Markets? Empirical Insights from a European Market

Abstract

This study examines the relationship between financial development and economic growth, and the extent to which the finance-leading hypothesis holds in Hungary by using annual time series data over the period 1970-2019. To test the hypotheses of the study, the autoregressive distributed lag approach and Granger causality test have been applied. The empirical findings show that there is a relationship between financial and economic growth, but the evidence of the supply-leading hypothesis in the long run in Hungary is varied according to the sector. While in the short run, the changes in the ratios of credit to both agencies of the private sector have no statistically significant impact on economic growth. According to the Granger test, there is evidence supporting the neutrality hypothesis for the credit-to-corporate ratio and the feedback hypothesis for the credit-to-household ratio in relation to economic growth. This is a consequence of the fact low levels of efficiency characterized the Hungarian financial system, despite it being characterized by high levels of financial depth. Besides, financial liberalization and financial development increased reliance on external finance, which caused the fragility of the financial system and the effect on its role in economic growth. Policymakers need to target the channels and financial efficiency mechanisms to influence and transform the real economy in all the regions of the country to equally develop goals and economic growth together and ensure stable macroeconomic policies.