Financial development and economic growth nexus for Pakistan: a revisit using maximum entropy bootstrap approach

Since the contribution of Schumpeter (in: The theory of economic development: an inquiry into profits, capital, credit, interest, and the business cycle, Harvard University Press, Cambridge, 1934), the relationship between financial development (FDT) and economic growth (EGT) has been analyzed at great level, however, still with ambiguous results regarding causal direction. Such mixed results are mainly due to the use of asymptotic theory-based econometric approaches like unit root and cointegration in finite samples. To overcome this, the present paper makes use of newly introduced state-of-the-art maximum entropy bootstrap (meboot) approach by Vinod (J Asian Econ 17(6):955–978, 2006) to examine the causal nexus between FDT and EGT for Pakistan. To see a better and wider picture, following the literature, two different cases (proxies) are considered: The first case uses capital to private sector as share of GDP to measure FDT and real GDP per capita to measure EGT, while the second case uses M2 as a proxy for FDT and private investment expenditure to proxy EGT. The empirical analysis based on annual time series data from 1973 to 2015 for Pakistan supports Robinson (in: The rate of interest and other essays, Macmillan & Co. Ltd., London, 1953) view of demand following hypothesis for Case 1 and a feedback relationship between the two in Case 2. Since meboot is a better and robust approach and results are unchallenged, we can say that one of the reasons apart from the use of asymptotic approaches to measure causal link between FDT and EGT is the use of different proxy variables for each FDT and EGT. These results have several important policy implications.