Friday, 16 March 2018: 3:20 PM
The impact of financial development on economic growth has been extensively debated in the literature since the seminal paper of Schumpeter (1934) considering finance as an engine of economic growth through its effects on innovative investments. However, some recent empirical literature casts some doubts on this relationship and reports a minor role of financial development in driving economic growth or a non-monotone linkage between financial development and economic growth. The paper investigates empirically this relationship in the case of 11 Emerging European Countries (EEC) over the period of 1995-2016 by using recent dynamic panel estimation models, including the pooled mean group estimator of Pesaran, Shin and Smith (1999), the mean group estimator of Pesaran and Smith (1995), the dynamic version of the common correlated effects estimator by Chudik and Pesaran (2015), and the panel threshold model of Hansen (1999). The findings, when imposing a linear relationship, suggest that financial development produces harmful effects on economic growth in the EEC in the long-run, but, positive effects in the short-run. When studying the hypothesis of non-linearities linked to the finance-growth nexus (using panel threshold models), the relationship becomes more and more negative after a certain threshold. In terms of policy implications, the governments should focus on efficient investment projects to boost economic growth and to expand the banking sector. Furthermore, the low impact of finance on economic growth in some of these countries may indicate a low level of financial development (i.e., an underdeveloped financial sector), weak institutions or other macroeconomic vulnerabilities.