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Financial Development and Economic Growth: Evidence from Heterogeneous Panel Data of Low Income Countries

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  • Qayyum, Abdul
  • Siddiqui, Rehana
  • Hanif, Muhammad Nadim

Abstract

This paper examines empirical relationship between financial development and economic growth while incorporating the inflation rate effect on financial development for low income countries. The study focuses on both the indirect finance and the direct finance, separately as well as collectively. We apply most appropriate econometric methodology of Weinhold (1999) and Nair-Reichert and Weinhold (2001) for causality analysis in heterogeneous panel data. Two sets of results are reported. First, the relationship between financial development and economic growth from contemporaneous non-dynamic fixed effects panel estimation can at best be interpreted as mixed. Negative and statistically significant estimates of coefficient of the inflation and financial development interaction variable indicate that financial sector development is actually harmful for economic growth when inflation is rising. Second, in contrast with the recent evidence of Beck and Levine (2003), use of more appropriate econometric methodology of dynamic heterogeneous panel for causality analysis and a refined model reveal that there is no definite indication that finance spurs economic growth or growth spurs finance. Our findings are in line with the Lucas (1988) view on finance that the importance of financial matters is very badly over-stressed in popular and even much professional discussion.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23431.

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Date of creation: 2004
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Handle: RePEc:pra:mprapa:23431

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Keywords: Financial Development; Inflation; Economic Growth; Low Income Countries;

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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. Sangmok Choi & Bruce D. Smith & John H. Boyd, 1996. "Inflation, financial markets and capital formation," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 9-35.
  3. Nair-Reichert, Usha & Weinhold, Diana, 2001. " Causality Tests for Cross-Country Panels: A New Look at FDI and Economic Growth in Developing Countries," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 63(2), pages 153-71, May.
  4. Pedroni, Peter, 1999. " Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(0), pages 653-70, Special I.
  5. Hicks, J. R., 1969. "A Theory of Economic History," OUP Catalogue, Oxford University Press, number 9780198811633, September.
  6. Beck, T.H.L. & Levine, R. & Loayza, N., 2000. "Financial intermediation and growth: Causality and causes," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3125519, Tilburg University.
  7. Christopoulos, Dimitris K. & Tsionas, Efthymios G., 2004. "Financial development and economic growth: evidence from panel unit root and cointegration tests," Journal of Development Economics, Elsevier, vol. 73(1), pages 55-74, February.
  8. Beck, T.H.L. & Levine, R. & Loayza, N., 2000. "Finance and the sources of growth," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3125520, Tilburg University.
  9. repec:fth:wobaco:1083 is not listed on IDEAS
  10. Ross Levine, 1997. "Financial Development and Economic Growth: Views and Agenda," Journal of Economic Literature, American Economic Association, vol. 35(2), pages 688-726, June.
  11. Temple, Jonathan, 2000. " Inflation and Growth: Stories Short and Tall," Journal of Economic Surveys, Wiley Blackwell, vol. 14(4), pages 395-426, September.
  12. Thorsten Beck & Asli Demirgüç-Kunt & Ross Levine, 2001. "Legal Theories of Financial Development," Oxford Review of Economic Policy, Oxford University Press, vol. 17(4), pages 483-501.
  13. Hsiao, C. & Mountain, D.C. & Tsui, K.Y. & Chan, M.W.L., 1989. "Modeling Ontario Regional Electricity System Demand Using A Mixed Fixed And Random Coefficients Approach," Papers m8906, Southern California - Department of Economics.
  14. King, Robert G & Levine, Ross, 1993. "Finance and Growth: Schumpeter Might Be Right," The Quarterly Journal of Economics, MIT Press, vol. 108(3), pages 717-37, August.
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  16. Thorsten Beck & Ross Levine, 2002. "Stock Markets, Banks, and Growth: Panel Evidence," NBER Working Papers 9082, National Bureau of Economic Research, Inc.
  17. Khan, Mohsin S. & Senhadji, Abdelhak S. & Smith, Bruce D., 2006. "Inflation And Financial Depth," Macroeconomic Dynamics, Cambridge University Press, vol. 10(02), pages 165-182, April.
  18. van den Berg, Hendrik, 1997. "The relationship between international trade and economic growth in Mexico," The North American Journal of Economics and Finance, Elsevier, vol. 8(1), pages 1-21.
  19. De Gregorio, Jose & Sturzenegger, Federico, 1997. "Financial markets and inflation under imperfect information," Journal of Development Economics, Elsevier, vol. 54(1), pages 149-168, October.
  20. Arellano, M, 1987. "Computing Robust Standard Errors for Within-Groups Estimators," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 49(4), pages 431-34, November.
  21. Boyd, John H. & Levine, Ross & Smith, Bruce D., 2001. "The impact of inflation on financial sector performance," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 221-248, April.
  22. Diana Weinhold, 2004. "A Dynamic “Fixed Effects” Model for Heterogeneous Panel Data," Econometrics 0410003, EconWPA.
  23. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
  24. Klaus Neusser & Maurice Kugler, 1998. "Manufacturing Growth And Financial Development: Evidence From Oecd Countries," The Review of Economics and Statistics, MIT Press, vol. 80(4), pages 638-646, November.
  25. A. R. Kemal, 2000. "Financing Economic Development," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 39(4), pages 293-311.
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Cited by:
  1. Selim Yildirim & Bilge Kagan Özdemir & Burhan Dogan, 2013. "Financial Development and Economic Growth Nexus in Emerging European Economies: New Evidence from Asymmetric Causality," International Journal of Economics and Financial Issues, Econjournals, vol. 3(3), pages 710-722.

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