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Determinants of the link between financial and economic development: Evidence from a functional coefficient model

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  • Herwartz, Helmut
  • Walle, Yabibal M.

Abstract

Noting that “one size does not fit all” in the case of the finance–development (FD) relationship, a growing body of literature has recently focused on uncovering economic conditions under which financial development could be beneficial (detrimental) to economic development. We look into these conditions by means of a flexible semiparametric approach that allows the long-run FD link to depend on measurable economic factors. Using annual data for 73 economies spanning the period 1975–2011, we find that the impact of finance on economic development is generally stronger in high-income than low-income economies. However, allowing for intra-group variations reveals the importance of other factor variables in explaining the FD link. For instance, increasing financial development strengthens the FD link while increasing government size weakens it. Moreover, the FD link could even be negative if low- and lower-middle-income economies have very large governments or are extremely open to international trade.

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  • Herwartz, Helmut & Walle, Yabibal M., 2014. "Determinants of the link between financial and economic development: Evidence from a functional coefficient model," Economic Modelling, Elsevier, vol. 37(C), pages 417-427.
  • Handle: RePEc:eee:ecmode:v:37:y:2014:i:c:p:417-427
    DOI: 10.1016/j.econmod.2013.11.029
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    Cited by:

    1. Linh Bun & Nirvikar Singh, 2016. "Heterogeneous Patterns of Financial Development: Implications for Asian Financial Integration," International Economic Journal, Taylor & Francis Journals, vol. 30(2), pages 243-271, June.
    2. repec:scm:ecofrm:v:5:y:2016:i:s:p:7 is not listed on IDEAS
    3. repec:eee:finana:v:56:y:2018:i:c:p:193-207 is not listed on IDEAS
    4. Raihan, Selim & Osmani, S.R. & Khalily, M.A. Baqui, 2017. "The macro impact of microfinance in Bangladesh: A CGE analysis," Economic Modelling, Elsevier, vol. 62(C), pages 1-15.
    5. Herwartz, Helmut & Walle, Yabibal M., 2014. "Openness and the finance-growth nexus," Journal of Banking & Finance, Elsevier, vol. 48(C), pages 235-247.
    6. Chow, Sheung Chi & Vieito, João Paulo & Wong, Wing-Keung, 2018. "Do both demand-following and supply-leading theories hold true in developing countries?," MPRA Paper 87641, University Library of Munich, Germany.
    7. Nahed Zghidi & Zouheir Abida, 2014. "Financial Development, Trade Openness and Economic Growth in North African Countries," Romanian Economic Journal, Department of International Business and Economics from the Academy of Economic Studies Bucharest, vol. 17(53), pages 91-120, September.
    8. repec:eee:quaeco:v:66:y:2017:i:c:p:136-148 is not listed on IDEAS
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    10. Pradhan, Rudra P. & Arvin, Mak B. & Hall, John H. & Bahmani, Sahar, 2014. "Causal nexus between economic growth, banking sector development, stock market development, and other macroeconomic variables: The case of ASEAN countries," Review of Financial Economics, Elsevier, vol. 23(4), pages 155-173.
    11. Martin Feldkircher & Thomas Gruber & Isabella Moder, 2014. "Using a Threshold Approach to Flag Vulnerabilities in CESEE Economies," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 3, pages 8-30.
    12. repec:taf:oaefxx:v:4:y:2016:i:1:p:1185237 is not listed on IDEAS
    13. Zahir, Faathih & Masih, Mansur, 2018. "Is the lead-lag relationship between financial development and economic growth symmetric ? new evidence from Bangladesh based on ARDL ad NARDL," MPRA Paper 87577, University Library of Munich, Germany.
    14. Prettner, Catherine, 2016. "Nonlinearities and Parameter Instability in the Finance-Growth Nexus," Department of Economics Working Paper Series 5037, WU Vienna University of Economics and Business.
    15. Ziaurrahman, Muhammad & Masih, Mansur, 2016. "Is financial sector development an engine of economic growth? evidence from India," MPRA Paper 72121, University Library of Munich, Germany.
    16. Rudra P. Pradhan & Mak B. Arvin & Sara E. Bennett & Mahendhiran Nair & John H. Hall, 2016. "Bond Market Development, Economic Growth and Other Macroeconomic Determinants: Panel VAR Evidence," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 23(2), pages 175-201, June.
    17. Svatopluk Kapounek, 2017. "The Impact of Institutional Quality on Bank Lending Activity: Evidence from Bayesian Model Averaging," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 67(5), pages 372-395, October.
    18. repec:eee:intfin:v:51:y:2017:i:c:p:155-170 is not listed on IDEAS
    19. Catherine Prettner, 2016. "Nonlinearities and Parameter Instability in the Finance-Growth Nexus," Department of Economics Working Papers wuwp224, Vienna University of Economics and Business, Department of Economics.
    20. Fanta Ashenafi Beyene & Makina Daniel, 2016. "The Finance Growth Link: Comparative Analysis of Two Eastern African Countries," Comparative Economic Research, Sciendo, vol. 19(3), pages 147-167, September.
    21. repec:rfe:zbefri:v:34:y:2016:i:2:p:529-554 is not listed on IDEAS

    More about this item

    Keywords

    Finance–development relationship; Financial development; Economic development; Functional coefficient model;

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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