Exploring the Linkages between Financial Development, Savings, and Economic Growth in Ethiopia: Empirical Evidence Based Analysis

Ethiopia has experienced substantial growth in per capita income, domestic savings, and financial sector developments over the past four decades. This paper aims to examine the causal relationship between certain variables in Ethiopia from 1981 to 2023. The variables considered in this paper include per capita income, private sector credit, domestic savings, and the rate of change in the consumer price index. Per capita income and private sector credit are used as proxies to measure real economic growth and financial sector development, while the inflation rate plays a crucial role in controlling these variables. The model was estimated using the Autoregressive Distributive Lag (ARDL) model bounds cointegration test framework to investigate the existence of long-run integration among series. The Granger causality test based on the vector error correction model (VECM) was deployed in order to capture the long run equilibrium relationship among variables and to identify supportive hypotheses for the Ethiopian economy. The ADF unit root test was employed to determine whether variables remained stationary. The findings affirm the existence of bidirectional causal relationships among the variables. Thus, the Ethiopian economy adheres to a feedback or bidirectional hypothesis, which suggests that an expansion of real economic growth will favour efficient financial development and stimulate savings. Similarly, having a well-functional financial sector development and steadfast domestic resources plays a crucial role in promoting real economic growth. This paper also urges that the monetary authority should promptly encourage the development of a market-based financial system, which will be compatible with the development needs and offer more options for accessing financial markets.