Finance and Growth: Time Series Evidence on Causality
29 Pages Posted: 25 Jan 2013 Last revised: 10 Jan 2015
Date Written: January 24, 2013
This paper re-examines the empirical relationship between financial and economic development while (i) taking into account their dynamics and (ii) differentiating between stock market and banking sector development. We study the cointegration and causality between the real and the financial sector for 26 countries. Our time series analysis suggests that the evidence in support of a finance-led growth is weak once we take into account the dynamics of financial development and growth. We show that causality patterns depend on whether countries' financial development stems from the stock market or the banking sector. Stock market development tends to cause growth, while a reverse or bi-directional causality is present between banking sector development and output growth. We also bring evidence that causality patterns differ between market-based and bank-based economies suggesting that financial structure influences the causal direction between financial and economic development. Thus, the relation between financial and economic development is likely to be more complex than suggested in earlier studies.
Keywords: economic development, stock market development, banking development, cointegration, causality
JEL Classification: C22, E44, O16, G21
Suggested Citation: Suggested Citation