Abstract
Problem statement: This study investigated the causal relationship between financial development and economic growth for Greece for the period 1978-2007 using a Vector Error Correction Model (VECM). Questions were raised whether financial development causes economic growth or reversely taking into account the positive effect of industrial production index. Financial market development is estimated by the effect of credit market development and stock market development on economic growth. The objective of this study was to examine the causal relationships between these variables using Granger causality tests based on a Vector Error Correction Model (VECM). Approach: To achieve this objective unit root tests were carried out for all time series data in their levels and their first differences according to Dickey-Fuller (1979). Johansen co-integration analysis was applied to examine whether the variables are co-integrated of the same order taking into account the maximum eigenvalues and trace statistics tests. A vector error correction model was selected to investigate the long-run relationship between financial development and economic growth. Finally, Granger causality test was applied in order to find the direction of causality between the examined variables of the estimated model. Results: A short-run increase of stock market index per 1% leaded to an increase of economic growth per 0.06% in Greece, also an increase of bank lending per 1% leaded to an increase of economic growth per 0.14% in Greece, while an increase of productivity per 1% leaded to an increase of economic growth per 0.32% in Greece. The estimated coefficient of error correction term found statistically significant with a negative sign, which confirmed that there was not any problem in the long-run equilibrium between the examined variables. The results of Granger causality tests indicated that economic growth causes stock market development and industrial production index, while industrial production index causes credit market development for Greece. Conclusions: Therefore, it can be inferred that economic growth has a positive effect on stock market development and credit market development through industrial production growth in 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% and 5% levels of significance (Table 1)
The results of the DF and Augmented Dickey-Fuller (ADF) tests show that the null hypothesis of the presence of a unit root is rejected for all variables when they are transformed into their first differences (Table 1)
Summary
The relationship between economic growth and financial development has been an extensive subject of empirical research. The question is whether financial development causes economic growth or reversely. The main objective of this paper was to investigate the causal relationship between economic growth and financial development taking into account the positive financial intermediaries and argues that these are essential for innovation and development. The theoretical relationship between financial development and economic growth goes back to the study of[1] who focuses on the services provided by the demand for financial services and not vice versa. Financial development follows economic growth as a result of increased demand for financial services. This explanation was originally advanced by[3]
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