Economic volatility and financial deepening in Sub-Saharan Africa: evidence from panel cointegration with cross-sectional heterogeneity and endogenous structural breaks

We study the impact of financial deepening on economic volatility for Sub-Saharan African countries (SSA) from 1982 to 2019 in a trivariate panel cointegration framework. Two measures, broad money and domestic credit as a percentage of GDP, are used to capture the financial deepening holistically. The analysis considers the possibility of cross-sectional heterogeneity and endogenous structural breaks. The study finds that financial deepening indicators share a long-term relationship with economic volatility. Panel parameter estimates by Dynamic OLS (ordinary least square), Pooled Mean Group, and Fully Modified OLS suggest that broad money influences economic volatility positively when financial deepening is represented by broad money. On the other hand, when domestic credit is chosen as the proxy for financial deepening, the impact is negative. Thus, while domestic credit helps lower economic volatility, broad money increases it. At the same time, the estimators indicate that broad money has a stronger relationship with economic volatility as compared to domestic credit for SSA countries. The study offers policy suggestions based on the empirical findings that emphasise financial inclusion and wider credit availability through the spread of the banking network for attaining the goal of reduced GDP volatility and steady economic development. An increase in the money supply might lead to increased economic activity in the short run but results in increased GDP volatility over the longer term.