An Empirical Reassessment of the Relationship Between Finance and Growth

Giovanni Favara

No 2003/123, IMF Working Papers from International Monetary Fund

Abstract: This paper reexamines the empirical relationship between financial development and economic growth. It presents evidence based on cross-section and panel data using an updated dataset, a variety of econometric methods, and two standard measures of financial development: the level of liquid liabilities of the banking system and the amount of credit issued to the private sector by banks and other financial institutions. The paper identifies two sets of findings. First, in contrast with the recent evidence of Levine, Loayza, and Beck (2001), cross-section and panel-data-instrumental-variables regressions reveal that the relationship between financial development and economic growth is, at best, weak. Second, there is evidence of nonlinearities in the data, suggesting that finance matters for growth only at intermediate levels of financial development. Moreover, using a procedure appropriately designed to estimate long-run relationships in a panel with heterogeneous slope coefficients, there is no clear indication that finance spurs economic growth. Instead, for some specifications, the relationship is, puzzlingly, negative.

Keywords: WP; economic growth; dependent variable; time series; Financial development; panel methods; GMM estimator; PMG estimator; panel estimator; slope coefficient; growth rate; two-step GMM estimator; two-step estimator; system GMM estimator; Financial sector development; Estimation techniques; Financial sector; Financial statistics; Threshold analysis; Africa (search for similar items in EconPapers)
Pages: 46
Date: 2003-06-01
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Citations: View citations in EconPapers (102)

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