An Empirical Reassessment of the Relationship between Finance and Growth

By Giovanni Favara. Social Science Research Network, 2003

330 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Information Systems

View Paper: https://www.semanticscholar.org/paper/7e219b67b17329063ef79062a881eac2f16fe718

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Citations in the corpus

Assessing and Managing Rapid Credit Growth and the Role of Supervisory and Prudential Policies (2005, positive): “- 4 The literature generally identifies three main drivers of rapid credit growth:(3) • During the development phase of an economy, credit grows more quickly than output (Favara, 2003; King and Levine, 1993; and Levine, 1997).”
Nonlinearities in financial development–economic growth nexus: Evidence from sub-Saharan Africa (2017, background): “Admittedly, studies on the nonlinearities are still inconclusive (Aghion et al., 2005; Cecchetti and Kharroubi, 2012; Shen and Lee, 2006; Law and Singh, 2014; Adeniyi et al., 2015; Favara, 2003) although evidence appear to support the inverted U-shaped.”
Determinants of FDI in developed and developing countries: a quantitative analysis using GMM (2018, methodology): “In one-step estimators, the error terms are assumed to be independent and homoscedastic across the country and time, while two-step estimator uses the residuals of the first step to estimate consistently the variance-covariance matrix of residuals, relaxing the assumption of homoscedasticity (Favarr”
Does financial development affect growth? (2009, background): “Favara (2003) concludes that the importance of private credit and liquid liabilities (LL) upon economic growth is highly dependent on the choice of estimation method.”
Is More Finance Better? Disentangling Intermediation and Size Effects of Financial Systems (2014, neutral): “This literature focuses on financial intermediation and tests for nonlinearities in the finance-growth relationship (Rioja and Valev, 2004; Shen and Lee, 2006; Favara, 2003; Arcand et al., 2011; Cecchetti and Kharroubi, 2012).”
Credit Growth in Central and Eastern Europe: New (Over)Shooting Stars? (2006, background): “11 ECB Working Paper Series No 687 October 2006 causality, while nonlinearities in the relationship between nancial development and growth as well as country heterogeneity add to the problems of empirical analysis in this area (see discussion in Favara, 2003).”
Effect of financial development on economic growth in sub-Saharan Africa (2018, background): “Favara (2003) finds an S -shaped relationship between financial deepening and economic growth and concludes that at very low (high) levels of financial development, growth suffers (im- proves).”
Financial Sector Development, Economic Growth, and Poverty Reduction: A Literature Review (2009, background): “Federici and Caprioli (2009) show that more financially developed countries are able to avoid currency crises based on quarterly data for 39 countries over 1981 to 2000.”
Is the Relationship between Financial Development and Economic Growth Monotonic? Evidence from a Sample of Middle Income Countries (2015, neutral): “It is often argued that credit to the private sector is a better proxy of financial development (see Demetriades and Hussein, 1996; King and Levine, 1993a; Beck et al, 2000; Favara, 2003; Liang and Teng, 2006; Arcand et al., 2011).”
The FinTech Opportunity (2016, neutral): “Better financial systems provide a better allocation of capital, not necessarily more overall credit, as noted by Favara (2009) and Cechetti and Kharroubi (2012), who argued that the relation between credit and growth is not monotonic.7 One way to quickly see this is to examine the same data for…”
Service regulation and growth: evidence from OECD countries (2011, methodology): “Several works adopting the Rajan-Zingales approach noticed that the empirical relevance of the finance-growth nexus is subject to strong variability depending on the countries included in the sample (Favara, 2003), and loses statistical significance as developing countries are omitted (Carlin and Ma”