Finance-growth Link Research Articles

Does the monetary policy regime matter in the effect of credit on growth?

AbstractThis study sheds light on the finance–growth link by (i) carefully taking into account the lessons learned from the empirical literature, (ii) extending the period of analysis to include the years following the global financial crisis (GFC), (iii) adding the monetary‐policy regime as a concomitant factor in this relation, and (iv) running different specifications and following a robust econometric approach. We find that the positive effect of finance via credit vanishes between the end of the 1990s and the beginning of the 2000s, coinciding with most countries reaching a high level of bank credit and with the GFC. This finding is also observed if an inverted U‐shaped specification is used to capture the relation between finance and growth. As for the monetary‐policy regime, the results reveal that the inflation‐targeting strategy does not exert a positive influence on economic growth.

FOREIGN DIRECT INVESTMENT, EXCHANGE RATE AND FINANCE-GROWTH NEXUS

Present study revisits the financial market development and economic growth nexus by examining the path through which exchange rate determines the role of foreign direct investment on finance-growth link. Sample data represents 22 Asian countries for the period of 1998–2018. Following the categorization of World Bank, study divides the data in developing and developed countries. Findings depict that the developing countries can achieve maximum growth in times of fewer foreign direct investments and weaker home currency. While, developed countries can maximize their economic progression by increasing foreign direct inflows and appreciated home country’s currency. Policy makers of developing countries should develop guidelines that encourage their local industry to foster economic growth and make necessary steps to stabilize their currency. In comparison to this, regulators of developed countries should relax trade tariffs and quotas to increase foreign direct investments and economic growth. Keywords: Financial Market Development, Economic Growth, Exchange Rate, Foreign Direct Investment, Asian countries.

Finance-growth nexus in sub-Saharan Africa

Background: There is now significant empirical literature suggesting that finance is good for growth only up to a threshold level of financial development, becoming harmful after that level, in developed and developing countries. Aim: This study extends this literature that investigates non-linearities on the finance-growth link, by testing the inverted U -shape hypothesis in sub-Saharan African countries, which are among the least developed ones. Setting: 36 countries from sub-Saharan Africa over the period 1980–2015. Method: Estimation of quadratic dynamic panel data models by system-generalised method of moments. Results: Empirical results show that there is a hump-shaped relationship between financial development and economic growth in sub-Saharan African countries. Conclusion: Results suggest that the hypothesis of ‘too much finance harms economic growth’ also holds for low-income and less developed countries, but for much lower threshold levels of financial development than those of more developed and higher-income countries. As for policy implications, measures to strengthen finance quality and other growth-enhancing strategies need to be undertaken, rather than increasing finance size.

MEASURING CREDIT STRUCTURE IMPACT ON ECONOMIC GROWTH IN CROATIA USING (VECM) 1990-2018

Studies on the finance-growth link use different proxy variables for financial development. Among the most used is the total credit share in the GDP. Previous empirical studies show to be sensitive to the choice of the finance proxy indicator. Total credit share in the GDP appears biased in empirical modeling. Credit structure (loans to firms and households) prove to be more robust when used in the modeling. Credit structure reveals a different impact on economic growth showing lending policy impact varies depending on the credit structure. Researchers studying the finance-growth link must account for this when investigating supply leading and demand-following theories. Policymakers should also take care of the credit structure since loans to household discourage growth in the long run and are sensitive to economic shocks. We find empirical evidence to support both supply leading and demand- following theory. Bi-directional causality between private loans to firms/households and economic growth exists using Granger causality test. Private loans to firms and households economic growth exists using Granger causality test. Private loans to firms and households have a positive impact on economic growth in Croatia.

Inflation Effects on Finance-Growth Link: A Panel Smooth Transition Approach

Considering the effect of inflation on financial development and economic growth, in this paper we investigate the role of inflation in the effect of financial development on the economic growth in OPEC economies for the period of 1970 to 2015. For this purpose, we used Panel Smooth Threshold Regression (PSTR) to estimate nonlinear effects of inflation in the relation between economic growth and financial development. The results of estimation show that the thresholds of inflation rate were 20.33 and 20.36 considering the two different proxies of financial development (domestic credit provided by banking and domestic credit to private sector). The results of nonlinear estimation showed that in over-threshold inflations, the effect of financial development on the economic growth in the OPEC economies would decrease and would even become negative.

Has the finance–growth link been broken? Panel data evidence from Latin America and the Caribbean

Abstract This paper examines the two-way relationship between economic growth and financial development for Latin America and the Caribbean (LAC). The sample consists of 32 emerging and developing countries from LAC spanning the period 1970–2014. Controlling for country and time fixed effects, the first central finding indicates that financial development is not a significant factor driving economic growth. The evidence suggests however that larger government has a robust and significant effect on economic growth. The second key finding is that the effect of economic growth on financial development is not significantly different from zero. Together, these two main findings indicate that the finance–growth link in LAC has been broken over the 1970–2014 period. The empirical results inform economic debates in LAC and highlight the importance of public policy to improve the finance–growth relationship.

Bond markets, stock markets, banks and growth: a system GMM analysis

Empirical studies on the finance-growth nexus largely focus on banks and stock markets to the exclusion of bond markets. Furthermore, such important events as bank crisis are neglected in most finance-growth models. The major aim of this paper is therefore to throw light at the finance growth link by accounting for bond markets and controlling for banking sector crisis using data on economic growth and financial development indicators of 36 economies comprising 21 advanced and 15 emerging economies. Applying a system generalised-method-of-moments (GMM) technique, the study revealed that bond markets rather than banks and stock markets are related to economic growth in advanced economies, and the same relationship is not found for emerging economies. It is further observed that the finance-growth link depends on the specific measures used to gauge financial development. This study also confirms previous findings that crisis dampens the finance-growth link. Two important inferences could be made from the results of this study. First, the often reported positive link between finance and growth might be caused by aggregation of countries of different economic growth and financial development. Second, the finance growth link depends on the measures of financial development used.

The Finance Growth Link: Comparative Analysis Of Two Eastern African Countries

This paper examines the finance growth link of two low-income Sub-Saharan African economies – Ethiopia and Kenya – which have different financial systems but are located in the same region. Unlike previous studies, we account for the role of non-bank financial intermediaries and formally model the effect of structural breaks caused by policy and market-induced economic events. We used the Vector Autoregressive model (VAR), conducted impulse response analysis and examined variance decomposition. We find that neither the level of financial intermediary development nor the level of stock market development explains economic growth in Kenya. For Ethiopia, which has no stock market, intermediary development is found to be driven by economic growth. Three important inferences can be made from these findings. First, the often reported positive link between finance and growth might be caused by the aggregation of countries at different stages of economic growth and financial development. Second, country-specific economic situations and episodes are important in studying the relationship between financial development and economic growth. Third, there is the possibility that the econometric model employed to test the finance growth link plays a role in the empirical result, as we note that prior studies did not introduce control variables.

The Finance-Growth Nexus: Evidence from Emerging Markets

The finance growth literature ignores the role of bond markets in financing private investments. Moreover, the impact of bank crisis on the finance growth link has been largely overlooked. This paper aims at casting light at the finance growth link in emerging economies by accounting for bond markets and controlling for banking sector crises. Data on economic growth and financial development indicators for 15 emerging economies (drawn from Africa, Asia, Latin America, and Europe) were analysed using a system generalized-method-of-moments (GMM) technique. It is observed that while banking sector development is related to economic growth (albeit negatively), no statistically significant relation is observed between stock markets and or bonds markets and economic growth. Moreover, a banking crisis is found to affect the finance growth link in such a manner that the link weakens when a banking crisis is introduced to the model. Our results are robust to omitted variable bias, simultaneity problem, heteroscedasticity and autocorrelation.

Openness and the finance-growth nexus

Rajan and Zingales (2003) hypothesize that openness—trade and financial—is a crucial determinant of financial development. The main policy implication emerging from this hypothesis is that openness should be promoted as a means of facilitating economic growth through financial development. While subsequent research confirms that openness affects financial development, we study whether finance continues to be growth promoting as economies become increasingly open—a key implicit assumption behind the policy recommendation. Using data from 78 economies for the period 1981–2006, we find that very high levels of financial openness generally erode the growth-promoting role of financial development while high trade openness strengthens it. These worldwide findings by and large hold for subsamples of Sub-Saharan African, Latin American and OECD economies. Notable exceptions are the invariance of the finance-growth (FG) nexus on trade openness in OECD economies and the positive effect of financial openness on the FG link in Latin American economies.

Revisiting the Finance–Growth Nexus in Sub‐Saharan Africa: Results from Error Correction‐based Panel Cointegration Tests

AbstractThis paper re‐examines the long‐run finance‐growth nexus in sub‐Saharan Africa (SSA) using data from 17 countries over the period 1975–2005. We apply error correction‐based panel cointegration tests that take into account cross‐sectional dependence among countries. Our results — unlike a previous study using the same data — indicate the existence of a long‐run relationship between financial and economic development in SSA countries. Moreover, our results clearly show that the long‐run causality runs from financial to economic development, although a muted support for the reverse causal impact is observed when financial development is measured by the percentage of liquid liabilities in GDP. The estimated long‐run parameters measuring the finance–growth link are positive and statistically significant. Therefore, our results strongly support policies aimed at developing the financial sector in SSA in order to promote long‐run economic development.

Access to Finance Thresholds and the Finance-Growth Nexus

Based on Aghion et al. (2005), this article provides new insights regarding whether financial development can affect economic growth non-linearly by adopting the concept of threshold effects. The empirical approach adopted in this article allows for the finance-growth relationship to be piecewise linear with a set of indicators including access to finance acting as a regime-switching trigger. Using cross-country observations from 144 countries stretching from 1985 to 2009, strong evidence of threshold effects in finance-growth link is found. It is suggested that financial development in general, and access to finance in particular, is among the important forces contributing to cross-country (non)-convergences in growth rates.

State Dependence in the Finance-growth Nexus: A Functional Coefficient Approach

Noting that one size does not fit all in the case of the finance-growth (FG) nexus, a growing body of literature has recently focused on uncovering economic conditions under which financial development could be beneficial (detrimental) to economic development. We look into these conditions by means of a flexible semiparametric approach which allows the long-run FG nexus to depend on measurable economic states. Using annual data for 74 economies spanning the period 1975-2005, we find that the level of financial development shows a strong positive impact on the FG nexus. Moreover, although the impact of finance on growth is generally higher in high-income economies, allowing for intra-group variations reveals scenarios where the impact could be higher in low-income economies. However, the FG link could also be negative if low- and lower-middle-income economies have very large governments or are extremely open to international trade.

Inflation Effects on Finance-Growth Link: A Panel Smooth Threshold Approach

This paper proposes an original framework to examine whether the strength of the relationship between financial development and economic growth, widely documented in the recent empirical literature, varies with the inflation rate. Using a Panel Smooth Threshold Regression for 71 developed and developing countries over the period 1960–2004, we find a non-linear link between financial development and economic growth: three equilibriums are identified with inflation rate. Then, there is an inflation threshold, for which finance ceases to increase economic growth. Our results suggest that for an inflation rate higher than 20%, economic growth is not, or is negatively, affected by financial development, whereas the impact of finance on growth is positive and significant for an inflation level below 10%.

A Fragile Link? A New Empirical Analysis of the Relationship between Financial Development and Economic Growth

This article contributes to the literature on the finance–growth link by presenting new findings based on a new, larger dataset that is an improvement on earlier studies due to its greater coverage in terms of time periods and countries, as well as the incorporation of additional control variables such as institutional quality and the investment rate. Our results demonstrate that financial development does not have a statistically significant effect on economic growth, a finding that is robust to different model specification and estimation techniques. This suggests that the finance–growth link is not as strong as portrayed in the literature, being dependent on the sample of countries and time periods considered.

Finance - Growth Nexus : Evidence from Sri Lanka

This study investigates the relationship between financial development and economic growth of Sri Lanka using time series data from 1960 to 2008. Cointegration and causality tests are conducted to assess the finance-growth link by taking saving, investment, trade and real interest rate into account. The empirical results show that economic growth causes financial development in the long-run and there is no reverse causation. This conclusion of the study goes in line with the views expressed by Demetriades and Hussein (1996), Macri and Sinha (2001) and Abma and Fase (2003) but departs distinctively from the observations made by Ahmed and Ansari (1998), on the finance-growth link in relation to Sri Lanka. The results of this research also show that the investment causes the economic growth which in turn results in demand for financial services to follow the growth in the real sector of the economy. This study has further identified that Sri Lanka’s financial system has shown some weaknesses in performing its tasks which would have been instrumental in the determination of causality pattern between financial sector development and economic growth of the country. DOI: <a href="http://dx.doi.org/10.4038/ss.v40i1.4679">http://dx.doi.org/10.4038/ss.v40i1.4679</a> Staff Studies – Volume 40 Numbers 1 &amp; 2, 1-36

WHAT IS HAPPENING TO THE IMPACT OF FINANCIAL DEEPENING ON ECONOMIC GROWTH?

I. INTRODUCTION Among the strongest elements of the modern economists' canon is that financial sector development has a significant impact on economic growth. A generation ago, economists like Goldsmith (1969) (1) and McKinnon (1973) began to draw attention to the benefits of financial structure development and financial liberalization. By the early 1990s, McKinnon (1991, 12) could write with confidence that: Now, however, there is widespread agreement that flows of saving and investment should be voluntary and significantly decentralized in an open capital market at close to equilibrium interest rates. Since the 1990s, a burgeoning empirical literature has illustrated the importance of financial sector development for economic growth. Despite the growing consensus, however, we find that the link between finance and growth in cross-country panel data has weakened considerably over time. At the very time that financial sector liberalization spread around the world, the influence of financial sector development on economic growth has diminished. The seminal empirical work that established the growth-finance link is King and Levine (1993), which extended the cross-country framework introduced in Barro (1991) by adding financial variables such as the ratios of liquid liabilities or claims on the private sector to gross domestic product (GDP) to the standard growth regression. They found a robust, positive, and statistically significant relationship between initial financial conditions and subsequent growth in real per capita incomes for a cross-section of about 80 countries. In the subsequent decade numerous empirical studies expanded upon this, using both cross-country and panel data sets for the post-1960 period. (2) In this paper we reexamine the core cross-country panel result and find that the impact of financial deepening on growth is not as strong with more recent data as it appeared in the original panel studies with data for the period from 1960 to 1989. We consider various explanations for this clear shift. First, we suggest that financial deepening has a positive effect on growth if not done to excess. Rapid and excessive deepening, as manifested in a credit boom, can be problematic even in the most developed markets because it can both weaken the banking system and bring inflationary pressures. We test this hypothesis by looking at the finance-growth nexus among countries that have or have not experienced financial sector crises. We find that once crisis episodes are removed, the finance-growth relationship remains intact. Its weakening over time thus seems to be a result of an increased incidence of crises in later years. Our second and related hypothesis is that the widespread liberalization of financial markets that occurred in the late 1980s and early 1990s made financial deepening less effective. This is reminiscent of Robert Lucas's (1975) critique of econometric policy evaluation advanced three decades ago. Policies that have promoted and/or forced increases in financial depth over the past two decades may have altered the basic structural relationship between finance and growth. This could occur if the observed benefits of financial deepening led many countries to liberalize before the associated legal and regulatory institutions were sufficiently well developed. As a consequence, the impact of financial deepening on growth would become smaller. Our evidence does not indicate that recent liberalizations are responsible for the breakdown of the finance-growth link. However, there may be an indirect link as premature financial development can lead to financial crises that have real effects. Third, we examine the role of global equity markets that have grown in importance and prominence in the years over which the finance-growth relationship disappeared. However, we do not find any evidence to suggest that equity market growth has substituted for the role of credit markets and banks in particular. …

The Fading Link? A New Empirical Analysis of the Relationship Between Financial Development and Economic Growth

This paper contributes to the literature on the finance-growth link by presenting new findings based on a new, larger dataset that improves over earlier studies in its greater coverage in terms of time periods and countries, as well as the incorporation of additional control variables like institutional quality and the size of the economy. Our results demonstrate that financial development does not have a statistically significant effect on economic growth. We also find that the economy’s size is a statistically significant determinant of growth.

The Finance–Growth Link in Latin America

This paper analyzes the relationship between financial development and economic growth in Latin America with a Granger causality test and impulse response functions in a panel vector autoregression (VAR) model. With annual observations from a sample of 18 countries from 1962 to 2005, it is shown that while economic growth causes financial development, financial development does not cause economic growth. This finding is robust to different model specifications and different financial indicators. Interestingly, when the sample is divided according to different income levels and institutional quality, there is two‐way causality between financial development and economic growth only for the middle income group and for countries with stronger rule of law and creditor rights. The impulse response functions show that a shock to financial development has a positive impact on economic growth only for these subsamples, but the net effect of financial development on growth is relatively small.

Inflation, financial development, and growth: A trilateral analysis

A large body of evidence links financial development to economic growth, yet the channels through which inflation affects this relationship and its stability have been less thoroughly explored. We take an econometric and graphical approach to examining these channels, and find that higher levels of financial development, combined with low-inflation, are related to higher rates of economic growth, especially in lower income countries, but that financial development loses much of its explanatory power in the presence of high-inflation. In particular, small increases in the price level seem able to wipe out relatively large growth effects of financial deepening when the annual rate of inflation lies between 4% and 19%, whereas the operation of the finance–growth link is less affected by inflation rates above this range. Growth is generally much lower, however, in such high-inflation settings where financial development is typically repressed.