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Does finance lead or lag economic growth ? the Malaysian evidence

Author

Listed:
  • Hakim, Idwan
  • Masih, Mansur

Abstract

The focus of this paper is to investigate the lead-lag or the causal relationship between financial development and economic growth in Malaysia. There are two alternative views – supply-leading and demand-following. Supply-leading view argues that finance leads to growth, while demand-following hypothesis contends that economic growth creates increasing demand for financial services. Since Malaysia is a small, highly open economy, the analysis takes into consideration development in trade openness. The paper applied the standard time series techniques on annual data incorporating cointegration tests, vector error correction models, variance decompositions and impulse response functions. Our findings offer support for the presence of long run relationships between finance and growth in Malaysia. Furthermore, the results consistently support the demand-following hypothesis for Malaysia. In other words, economic growth tends to lead financial development. This is in line with the findings of Ang and McKibbin (2007), which also found support for the demand-following hypothesis in Malaysia. The findings, in general, concur with the roles that the Malaysian financial sector has played in enabling growth performance. Going forward, more effective intermediation process, better allocation of resources to highly productive sectors, and more inclusive financial services may transform the roles of the financial sector from being a facilitator and enabler of growth, to a driver and catalyst of economic performance.

Suggested Citation

  • Hakim, Idwan & Masih, Mansur, 2016. "Does finance lead or lag economic growth ? the Malaysian evidence," MPRA Paper 99997, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:99997
    as

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    References listed on IDEAS

    as
    1. Muhammad Arshad Khan & Abdul Qayyum, 2007. "Trade Liberalisation, Financial Development and Economic Growth," Trade Working Papers 22204, East Asian Bureau of Economic Research.
    2. Wolde-Rufael, Yemane, 2009. "Re-examining the financial development and economic growth nexus in Kenya," Economic Modelling, Elsevier, vol. 26(6), pages 1140-1146, November.
    3. Mansur Masih & Ali Al-Elg & Haider Madani, 2009. "Causality between financial development and economic growth: an application of vector error correction and variance decomposition methods to Saudi Arabia," Applied Economics, Taylor & Francis Journals, vol. 41(13), pages 1691-1699.
    4. Ang, James B. & McKibbin, Warwick J., 2007. "Financial liberalization, financial sector development and growth: Evidence from Malaysia," Journal of Development Economics, Elsevier, vol. 84(1), pages 215-233, September.
    5. Mansor Ibrahim, 2007. "The role of the financial sector in economic development: the Malaysian case," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 54(4), pages 463-483, December.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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