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Title: The study of the causal relationship of financial development and economic growth
Author: Chow, Julian
ISNI:       0000 0001 3548 5958
Awarding Body: University of Surrey
Current Institution: University of Surrey
Date of Award: 2008
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The present enquiry concerns whether there is a bi-directional causal relationship between financial development and economic growth. It contributes to the century of debate revolving around the issue of whether the financial sector is 'supply-leading' or 'demandfollowing' that is first raised by Patrick (1966). A new theoretical. model is developed to study the bi-directional relationship of the finance-growth nexus. The model shows that the provision of liquidity in the banking system, by preventing premature liquidation of capital and improvement ofrisk sharing through inter-mediation, results in a larger capital accumulation in the economy. This justifies the existence and development of the financial sector in the economy. Financial development in tum can exert a positive effect on long-run economic growth through the interest-rate channel by increasing bank competition and by increasing the efficiency of financial intermediation. Economic growth in the real sector will generate more saving, thereby exerting a positive external effect on banking productivity and raising the wage rate for the bank. This will lead to a further financial development. The interaction will continue until the marginal. productivity oflabour becomes equal across the real sector and the financial sector. A maximum of 161 countries with a maximum time span ranging from 1965 to 2004is included in the cross-country empirical analysis using the Granger-Causality test with optimal lag-length selection criteria and the Simultaneous Equation Model Approach, to examine the bi-directional relationship. Results from the Granger-Causality test suggest that economies will shift from the demand-following pattern in the early stage of development to a .supply-leading pattern at the later stage of development, and thereby refutes the Patrick (1966) hypothesis that supply-leading pattern dominates in the early stage. Results from the Simultaneous Equation Model Approach suggest that the relationship for the finance-growth nexus is reciprocal and give rises to a cumulative process. Policies that foster financial development and economic growth, such as private property rights protection, trade liberalisation policy, removal of inflation tax, population control, investment in education, raising private investment and government public expenditure, will therefore exert a cumulative beneficial effect to the economy. Insufficient financial development might therefore be a reason for the emergence of poverty trap, and insufficient economic growth might lead to underdevelopment of financial system that prevents the economy from taking off.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available