Law, Institutions and Finance: Time Series Evidence from India

Abstract

This paper revisits the financial development - economic growth puzzle from the perspective of the determinants of financial sector growth such as legal and institutional developments and financial regulation. We quantify the impact of these factors on financial sector and economic growth with the help of innovative time series indices that measure legal and institutional developments and financial regulation in India. Within a multivariate VAR framework, Granger Causality (GC) test and Vector Error Correction Model (VECM) are employed to investigate the long run causal relationships between the determinants and the financial sector. Our results show that legal and institutional developments and financial regulation cause financial sector growth with a considerable feedback and further financial sector weakly causes economic growth. Thus this paper completes the causal chain of links where legal and institutional development and regulatory measures cause economic growth by enhancing the financial sector.