Examining the co-integrating relationship between financial development and economic growth

Abstract

This study investigated the nexus between financial development and economic growth, exploring the short-run and long-run impact of financial development on economic growth in the Sothern African Development Community (SADC). The SADC was fragmented into middle-income countries and low-income countries so as to ascertain the income effect on the nature of the relationship, an exploration not considered by previous studies. The study used panel data covering the period 1980 to 2020. It employed the Autoregressive Distributed Lag (ARDL) Bounds and the Toda and Yamamoto and Dolado and Lütkepohl (TYDL) models to examine the relationship and the direction of causality respectively. In the short run, financial development, through domestic credit to the private sector, spurs economic growth and in the long run financial development focus should be on promoting bank deposits. Causality tests between economic growth and financial development tests showed mixed results depending on the variable used for measuring financial development. In addition, the SADC countries are encouraged to strengthen their financial sector legislation, strategies, and banking system supervision so as to enhance the financial sector efficiency as well as to realise the benefits of financial innovation.