Financial development and economic growth: New evidence from panel data

This study provides evidence on the role of financial development in accounting for economic growth in low- and middle-income countries classified by geographic regions. To document the relationship between financial development and economic growth, we estimate both panel regressions and variance decompositions of annual GDP per capita growth rates to examine what proxy measures of financial development are most important in accounting for economic growth over time and how much they contribute to explaining economic growth across geographic regions and income groups. We find a positive relationship between financial development and economic growth in developing countries. Moreover, short-term multivariate analysis provides mixed results: a two-way causality relationship between finance and growth for most regions and one-way causality from growth to finance for the two poorest regions. Furthermore, other variables from the real sector such as trade and government expenditure play an important role in explaining economic growth. Therefore, it seems that a well-functioning financial system is a necessary but not sufficient condition to reach steady economic growth in developing countries.