Financial depth, savings and economic growth in Kenya: A dynamic causal linkage

Abstract

The debate on the direction of causality between financial development and economic growth has been on-going since the 19th century. However, the majority of the previous studies on this subject have concentrated mainly on the use of the bi-variate causality test and may, therefore, suffer from the omission-of-variable bias. In addition, some of these studies have used cross-sectional data, which may not satisfactorily address country-specific issues. To this end, the current study attempts to examine the dynamic causal relationship between financial depth and economic growth in Kenya by including savings as an intermitting variable—thereby creating a simple tri-variate causality model. Using the cointegration and error-correction techniques, the empirical results of this study reveal that there is a distinct uni-directional causal flow from economic growth to financial development. The results also reveal that economic growth Granger causes savings, while savings drive the development of the financial sector in Kenya. The study, therefore, warns that any argument that financial development unambiguously leads to economic growth should be treated with extreme caution.