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Financial Deepening and Economic Growth in the European Transition Economies

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  • Mirdala, Rajmund

Abstract

Various effects of the financial deepening came to the centre of academics as well as policy-makers discussions during last four decades especially in relation to the financial sector development. Together with financial liberalization and international financial integration economists focus their attention to the financial deepening especially due to its potential effects on the real economy. Perspective of the fast and sustainable economic growth at the end of the 1990s increased an attractiveness of the European transition economies (ETE) for the foreign investors that resulted in increased foreign capital inflows to ETE. International capital inflows (especially debt and portfolio capital flows) stimulate financial deepening through higher demand for financial services. As the underdeveloped financial markets obviously constrain domestic capital mobilization, the international financial integration is considered to be very useful vehicle in fostering financial sector advancement. One of the most discussed areas related to the overall effects of the financial deepening is a bi-directional relationship between financial development and economic growth. It is generally expected there is a positive effect of financial development on economic growth. On the other hand especially some country-specific institutional characteristics and different policies may significantly distort positive incentives of the financial deepening. In the paper we analyze the main aspects of the financial deepening in ten ETE in the period 2000-2010 using vector error correction model (VECM). In order to meet this objective we implement a multivariate cointegration methodology introduced by Johansen (1988, 1991) and Johansen and Juselius (1990) to estimate the relationships between financial depth indicators and real output in the selected group of countries. To find the order of integration of endogenous variables we test the time series for the unit root presence. In order to determine cointegrating (long-run) relationships, we follow a Johansen cointegration procedure to perform the trace test and maximum eigenvalue test. We also test the direction of the causality relationships between financial depth indicators and real output using linear Granger causality test. Using the estimated VEC model, the dynamic responses of the endogenous variables to the money stock, domestic bank deposits and domestic bank loans one standard deviation shocks are computed for each country from the group of ETE.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 33609.

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Date of creation: Jun 2011
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Publication status: Published in Journal of Applied Economic Sciences 2.6(2011): pp. 177-194
Handle: RePEc:pra:mprapa:33609

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Keywords: financial deepening; economic growth; vector error correction model; granger causality; impulse-response function;

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  1. Piotr MISZTAL, 2010. "Foreign Direct Investments As A Factor For Economic Growth In Romania," Review of Economic and Business Studies, Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, issue 5, pages 39-53, June.
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  9. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 231-254.
  10. Suleiman Abu-Bader & Aamer Abu-Qarn, 2006. "Financial Developent and Economic Growth Nexus: Time Series Evidence from Middle Eastern and North African Countries," Working Papers, Ben-Gurion University of the Negev, Department of Economics 223, Ben-Gurion University of the Negev, Department of Economics.
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Cited by:
  1. Mirdala, Rajmund, 2011. "Financial Integration and Economic Growth in the European Transition Economies," MPRA Paper 36695, University Library of Munich, Germany.

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