Evidence on the Threshold Effect of Inflation on the Link between Credits to the Private Sector and Level of Financial Development

The role of the financial system, which mediates the transfer of funds to the real sector, is important for the efficient use of capital resources. Based on this motivation, the aim of this study is to determine the impact of the level of financial development on domestic loans given to the private sector depending on the inflation rate in the period 2002-2021 in the context of 54 emerging and developing countries. The study’s control variable is the rule of law. The empirical results obtained from the analyses carried out within the framework of the threshold regression model show that the inflation has a single threshold effect on the relationship between the level of financial development and the domestic credits to the private sector. Accordingly, in the period of inflation rates of 3.14% and below, the effect of the level of financial development on the domestic credits to the private sector is positive. In periods of inflation above 3.14%, the impact of the level of financial development on domestic credits to the private sector is still positive but less so. These findings provide empirical evidence that the degree of financial development in emerging and developing economies has a non-linear impact on the amount of domestic credits to the private sector, which is contingent on the level of inflation. In addition, the rule of law variable has an positive effect on the domestic credits to the private sector in the sample countries.