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An Empirical Reassessment of the Relationship Between Finance and Growth

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  • Giovanni Favarra
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    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.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 03/123.

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    Length: 46
    Date of creation: 01 Jun 2003
    Date of revision:
    Handle: RePEc:imf:imfwpa:03/123

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    Related research

    Keywords: Economic growth; Economic models; equation; statistics; gdp per capita; correlation; outliers; gdp growth; econometrics; samples; time series; mean group; growth rate; statistical significance; dummy variable; statistic; equations; functional form; degree of heterogeneity; linear trend; standard errors; measurement errors; instrumental variables; business cycles; real gdp; growth model; mean group estimator; predictions; outlier; empirical framework; neoclassical growth model; correlations; logarithm; independent variables; linear model; empirical specification; standard error; business cycle; covariance; per capita income; linear time; linear time trend; data analysis; horizontal axis; cointegration; normal distribution; growth rates; confidence intervals; linear regression; standard deviation; dummy variables; monte carlo simulation; nonlinear relationship; lagrange multiplier test; descriptive statistics; survey; linear models; growth analysis; bootstrap; additional regressor; financial statistics; sensitivity analysis; mean group estimation; significance levels; empirical model; empirical method;

    References

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    1. Pesaran, M. Hashem & Smith, Ron, 1995. "Estimating long-run relationships from dynamic heterogeneous panels," Journal of Econometrics, Elsevier, vol. 68(1), pages 79-113, July.
    2. Acemoglu, Daron & Zilibotti, Fabrizio, 1996. "Was Prometheus Unbound by Chance? Risk, Diversification and Growth," CEPR Discussion Papers 1426, C.E.P.R. Discussion Papers.
    3. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998. "Law and Finance," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1113-1155, December.
    4. King, Robert G. & Levine, Ross, 1993. "Finance and growth : Schumpeter might be right," Policy Research Working Paper Series 1083, The World Bank.
    5. Caselli, Francesco & Esquivel, Gerardo & Lefort, Fernando, 1996. " Reopening the Convergence Debate: A New Look at Cross-Country Growth Empirics," Journal of Economic Growth, Springer, vol. 1(3), pages 363-89, September.
    6. Bencivenga, V.R. & Smith, B.D., 1988. "Financial Intermediation And Endogenous Growth," RCER Working Papers 124, University of Rochester - Center for Economic Research (RCER).
    7. Jonathan R. W. Temple, 1998. "Robustness tests of the augmented Solow model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 13(4), pages 361-375.
    8. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 87(1), pages 115-143, August.
    9. Li, Q. & Wang, Suojin, 1998. "A simple consistent bootstrap test for a parametric regression function," Journal of Econometrics, Elsevier, vol. 87(1), pages 145-165, August.
    10. Kalaitzidakis, P. & Mamuneas, T.P. & Savvides, A. & Stengos, T., 2000. "Measures of Human Capital and Nonlinearities in Economic Growth," Working Papers 2000-5, University of Guelph, Department of Economics and Finance.
    11. Stanley Fischer, 1993. "The Role of Macroeconomic Factors in Growth," NBER Working Papers 4565, National Bureau of Economic Research, Inc.
    12. Greenwood, J. & Jovanovic, B., 1990. "Financial Development, Growth, And The Distribution Of Income," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9002, University of Western Ontario, The Centre for the Study of International Economic Relations.
    13. King, Robert G. & Levine, Ross, 1993. "Finance and growth : Schumpeter might be right," Policy Research Working Paper Series 1083, The World Bank.
    14. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
    15. Canova, Fabio & Marcet, Albert, 1995. "The Poor Stay Poor: Non-Convergence Across Countries and Regions," CEPR Discussion Papers 1265, C.E.P.R. Discussion Papers.
    16. Pesaran, M.H., 1996. "The Role of Economic Theory in Modelling the Long Run," Cambridge Working Papers in Economics 9612, Faculty of Economics, University of Cambridge.
    17. Liu, Zhenjuan & Stengos, Thanasis, 1999. "Non-linearities in Cross-Country Growth Regressions: A Semiparametric Approach," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(5), pages 527-38, Sept.-Oct.
    18. Azariadis, Costas & Drazen, Allan, 1990. "Threshold Externalities in Economic Development," The Quarterly Journal of Economics, MIT Press, vol. 105(2), pages 501-26, May.
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    Citations

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    Cited by:
    1. Pasali, Selahattin Selsah, 2013. "Where is the cheese ? synthesizing a giant literature on causes and consequences of financial sector development," Policy Research Working Paper Series 6655, The World Bank.
    2. Mwanza Nkusu & Selin Sayek, 2004. "Local Financial Development and the Aid-Growth Relationship," IMF Working Papers 04/238, International Monetary Fund.
    3. Papaioannou, Elias, 2007. "Finance and growth: a macroeconomic assessment of the evidence from a European angle," Working Paper Series 0787, European Central Bank.
    4. Simplice A, Asongu, 2011. "Finance and growth: Schumpeter might be wrong in our era. New evidence from Meta-analysis," MPRA Paper 32559, University Library of Munich, Germany, revised 07 Feb 2013.
    5. Patrick Honohan, 2004. "Financial development, growth, and poverty: how close are the links?," Policy Research Working Paper Series 3203, The World Bank.
    6. International Monetary Fund, 2004. "Financial Sector Development in the Middle East and North Africa," IMF Working Papers 04/201, International Monetary Fund.
    7. Zhuang, Juzhong & Gunatilake, Herath & Niimi, Yoko & Ehsan Khan, Muhammad & Jiang, Yi & Hasan, Rana & Khor, Niny & S. Lagman-Martin, Anneli & Bracey, Pamela & Huang, Biao, 2009. "Financial Sector Development, Economic Growth, and Poverty Reduction: A Literature Review," ADB Economics Working Paper Series 173, Asian Development Bank.
    8. Michael Graff, 2005. "Is There an Optimum Level of Financial Activity?," KOF Working papers 05-106, KOF Swiss Economic Institute, ETH Zurich.
    9. Man-Keung Tang, 2007. "Private-Sector Financial Liabilities in Advanced Economies," IMF Working Papers 07/118, International Monetary Fund.
    10. Egert, Balázs & Backé, Peter & Zumer, Tina, 2006. "Credit growth in Central and Eastern Europe: new (over)shooting stars?," Working Paper Series 0687, European Central Bank.
    11. Guglielmo Barone & Federico Cingano, 2008. "Service regulation and growth: evidence from OECD countries," Temi di discussione (Economic working papers) 675, Bank of Italy, Economic Research and International Relations Area.
    12. REY, Serge, 2005. "Convergence réelle et convergence nominale dans les Pays de la région MENA
      [Real and nominal convergence amongst MENA countries]
      ," MPRA Paper 30206, University Library of Munich, Germany.
    13. Antonín Rusek, 2005. "Financial Integration and the New EU Member Countries: Challenges and Dilemmas," Prague Economic Papers, University of Economics, Prague, vol. 2005(1), pages 17-32.
    14. Ceyla Pazarbasioglu & Gudrun Johnsen & Paul Louis Ceriel Hilbers & Inci Ötker, 2005. "Assessing and Managing Rapid Credit Growth and the Role of Supervisory and Prudential Policies," IMF Working Papers 05/151, International Monetary Fund.

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