An Empirical Reassessment of the Relationship between Finance and Growth

47 Pages Posted: 30 Jan 2006

See all articles by Giovanni Favara

Giovanni Favara

HEC University of Lausanne; Ecole Polytechnique Fédérale de Lausanne; International Monetary Fund (IMF)

Date Written: June 2003

Abstract

This paper reexamines the empirical relationship between financial development and economic growth. It presents evidence based on cross-section and panel data using an updated dataset, a variety of econometric methods, and two standard measures of financial development: the level of liquid liabilities of the banking system and the amount of credit issued to the private sector by banks and other financial institutions. The paper identifies two sets of findings. First, in contrast with the recent evidence of Levine, Loayza, and Beck (2001), cross-section and panel-data-instrumental-variables regressions reveal that the relationship between financial development and economic growth is, at best, weak. Second, there is evidence of nonlinearities in the data, suggesting that finance matters for growth only at intermediate levels of financial development. Moreover, using a procedure appropriately designed to estimate long-run relationships in a panel with heterogeneous slope coefficients, there is no clear indication that finance spurs economic growth. Instead, for some specifications, the relationship is, puzzlingly, negative.

Keywords: Financial development, economic growth, panel methods

JEL Classification: O16, O40

Suggested Citation

Favara, Giovanni, An Empirical Reassessment of the Relationship between Finance and Growth (June 2003). IMF Working Paper No. 03/123, Available at SSRN: https://ssrn.com/abstract=879199 or http://dx.doi.org/10.2139/ssrn.879199

Giovanni Favara (Contact Author)

HEC University of Lausanne ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland

HOME PAGE: http://www.hec.unil.ch/gfavara/

Ecole Polytechnique Fédérale de Lausanne

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

International Monetary Fund (IMF)

700 19th Street, N.W.
Washington, DC 20431
United States

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