Non-linear growth effects of financial development: Does financial integration matter?

Using both macro- and industry-level data this paper analyses the non-linear effects of financial development and international financial integration on economic growth in Europe. Special attention is devoted to modeling threshold effects with respect to the depth of financial markets as a measure of economies' absorption capacity. Results reveal evidence of significant non-linear effects, with less developed European countries gaining more from financial development. In contrast, benefits of international financial integration become significant at higher levels of financial development. The data show that monetary integration in Europe significantly contributed to a higher degree of financial integration. Entry of new EU members to the European Monetary Union may thus be the mechanism ensuring a virtuous development circle, as the adoption of the Euro may allow the development of domestic financial markets and financial integration to go hand-in-hand.