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

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

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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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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  1. Beck, Thorsten & Levine, Ross & Loayza, Norman, 2000. "Finance and the sources of growth," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 261-300.
  2. 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.
  3. Beck, Thorsten & Levine, Ross, 2004. "Stock markets, banks, and growth: Panel evidence," Journal of Banking & Finance, Elsevier, vol. 28(3), pages 423-442, March.
  4. A. R. Kemal, 2000. "Financing Economic Development," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 39(4), pages 293-311.
  5. Sangmok Choi & Bruce D. Smith & John H. Boyd, 1996. "Inflation, financial markets and capital formation," Review, Federal Reserve Bank of St. Louis, issue May, pages 9-35.
  6. 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.
  7. 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.
  8. Diana Weinhold, 2004. "A Dynamic “Fixed Effects” Model for Heterogeneous Panel Data," Econometrics 0410003, EconWPA.
  9. Jose De Gregorio & Federico Sturzenegger, 1994. "Credit Markets and the Welfare Costs of Inflation," NBER Working Papers 4873, National Bureau of Economic Research, Inc.
  10. 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.
  11. King, Robert G. & Levine, Ross, 1993. "Finance and growth : Schumpeter might be right," Policy Research Working Paper Series 1083, The World Bank.
  12. Levine, Ross & Loayza, Norman & Beck, Thorsten, 2000. "Financial intermediation and growth: Causality and causes," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 31-77, August.
  13. repec:fth:wobaco:1083 is not listed on IDEAS
  14. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
  15. 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.
  16. Peter Pedroni, 1999. "Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors," Department of Economics Working Papers 2000-02, Department of Economics, Williams College.
  17. 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.
  18. 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.
  19. Mohsin S. Khan & A. Senhadji Semlali & Bruce D. Smith, 2001. "Inflation and Financial Depth," IMF Working Papers 01/44, International Monetary Fund.
  20. repec:ner:tilbur:urn:nbn:nl:ui:12-3125516 is not listed on IDEAS
  21. Hicks, J. R., 1969. "A Theory of Economic History," OUP Catalogue, Oxford University Press, number 9780198811633, March.
  22. 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.
  23. Temple, Jonathan, 2000. " Inflation and Growth: Stories Short and Tall," Journal of Economic Surveys, Wiley Blackwell, vol. 14(4), pages 395-426, September.
  24. 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.
  25. repec:ner:tilbur:urn:nbn:nl:ui:12-3125519 is not listed on IDEAS
  26. 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.
  27. Pesaran, M.H. & Smith, R., 1992. "Estimating Long-Run Relationships From Dynamic Heterogeneous Panels," Cambridge Working Papers in Economics 9215, Faculty of Economics, University of Cambridge.
  28. repec:ner:tilbur:urn:nbn:nl:ui:12-3125520 is not listed on IDEAS
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