The Relationship Between Financial Development and Economic Growth in The United Kingdom: A Granger Causality Approach

Keywords: Granger Causality, Financial Development, Economic Growth, UK, Vector Error correction

Viewed = 27 time(s)

Abstract

This study aims to investigate the causal relationship between financial development and economic growth in the UK using quarterly data from 1963q1 to 2015q1. Three variables were used as proxies for financial sector development, namely, ratios of broad money supply to GDP, ratios of private sector credit to GDP and the ratios of stock market capitalization to GDP.  Economic growth was measured using real GDP per capita. In order to achieve stated aim, the study employed the Johansen Cointegration test and the Granger causality test within a vector error correction framework (VEC) to test for the existence (or not) of a long run relationship as well as the direction of causality between financial development and economic growth. The result from the Cointegration test indicates that there is a stable long run equilibrium relationship between financial development and economic growth in the UK. The Granger causality test presents evidence of a bidirectional causality. This suggests that financial development and economic growth are mutually causal, that is, causality runs from both side which is in line with the feedback hypothesis in the literature which argue that financial development and economic growth exhibits a two-way causal relationship. In terms of each individual variable, the study finds that while bank credit to the private sector and stock market capitalisation Granger cause GDP per capita, GDP per capita on the other hand, Granger causes broad money supply.



References

Abubakar, A., & Gani, I. M. (2013). Impact of Banking Sector Development on Economic Growth: Another Look at the Evidence from Nigeria. Journal of Business Management & Social Sciences Research, 2(4).
Acaravci, S. K., Ozturk, I., & Acaravci, A. (2009). Financial development and economic growth: literature survey and empirical evidence from sub-Saharan African countries. SAJEMS NS, 12(1).
Ahmed, S. M., & Ansari, M. I. (1998). Financial sector development and economic growth: The South-Asian experience. Journal of Asian Economics, 9(3), 503–517.
Akinboade, O. A. (1998). Financial development and economic growth in Botswana, a test for causality. Savings and Development, 22(3), 331-348.
Al-Khouri, R. S. (2007). Financial Sector Development and Sustainable Economic Growth in Regionally Co-Integrated Emerging Markets. Issues in Corporate Governance and Finance, 12, 345-360.
Al-Yousif, Y. K. (2002). Financial development and economic growth: Another look at the evidence from developing countries. Review of Financial Economics, 11, 131–150.
Ang, J. B. (2008). A Survey of Recent Developments in the Literature of Finance and Growth. Journal of Economic Surveys, 9(2), 132-160.
Apergis, N., Filippidis, I., & Economidou, C. (2007). Financial Deepening and Economic Growth Linkages: A Panel Data Analysis. Review of World Economics, 143(1), 179-198.
Apergis, N., Filippidis, I., & Economidou, C. (2007). Financial Deepening and Economic Growth Linkages: A Panel Data Analysis. Review of World Economics, 179-198.
Arestis, P., & Demetriades, P. (1997). Financial Development and Economic Growth: Assessing the Evidence. The Economic Journal, 783-799.
Asteriou, D., & Hall, S. G. (2011). Applied Econometrics (2nd ed.). Basingstoke: Macmillian.
Banerjee, A., Dolado, J. J., Galbraith, J. W., & Hendry, D. (1993). Co-integration, Error Correction, and the Econometric Analysis of Non-Stationary Data. New Yor: Oxford University Press.
Bank of England. (2015). Bankstats (Monetary & Financial Statistics) - December 2015. Retrieved from www.bankofengland.co.uk: http://www.bankofengland.co.uk/statistics/Pages/bankstats/2015/dec.aspx
Bank of International Settlement. (2015). Credit to the non-financial sector. Retrieved from www.bis.org: http://www.bis.org/statistics/totcredit.htm
Beck, T., Levine, R., & Loayza, N. (2000). Finance and the sources of growth. Journal of Financial Economics, 58, 261}300.
Bittencourt, M. (2012). Journal of Policy Modeling, 34, 341–355.
Blanco, L. (2009). The Finance-Growth Link in Latin America. Southern Economic Journal, 76(1), 224-248. Retrieved from ttp://www.jstor.org/stable/27751461
Blanco, L. (2009). The Finance-Growth Link in Latin America. Southern Economic Journal, 76(1), 224-248.
Boulila, G., & Trabelsi, M. (2002). Financial development and long-run growth: Granger causality in a bivariate VAR structure, evidence from Tunisia: 1962-1997. Working Paper, Faculte des Sciences Economiques et de Gestion de Tunis.
Calderon, C., & Lin, L. (2003). The direction of causality between financial development and economic growth. Journal of Development Economics(72), 321– 334.
Calderon, C., & Liu, L. (2003). The direction of causality between financial development and economic growth. Journal of Development Economics, 72, 321– 334.
Caporale, G. M., Rault, C., Sova, R., & Sova, A. (2009). Financial Development and Economic Growth: Evidence from Ten New EU Members. Berlin: DIW Berlin, German Institute for Economic Research.
Chang, T., & Caudill, S. B. (2005). Financial development and economic growth: the case of Taiwan. Applied Economics, 37(12), 329-1335.
Christopoulos, D. K., & Tsionas, E. G. (2004). Financial development and economic growth: evidence from panel unit root and cointegration tests. Journal of Development Economics, 73, 55– 74.
Chuah, H. L., & Thai, V.-C. (2004). Financial Development and Economic Growth: Evidence From Causality Tests For The GCC Countries. IMF Working Papper .
Cihák, M., Demirgüç-Kunt, A., Feyen, E., & Levine, R. (2013). Measuring financial development. Retrieved from www.voxeu.org: http://www.voxeu.org/article/measuring-financial-development
Cojocaru, L., Hoffman, S., & Miller, J. (2012). Financial Development and Economic Growth in Transition Economies: Empirical Evidence from the CEE and CIS Countries. Department of Economics, University of Delaware, Newark, Working Paper Series.
Darrat, A. (1999). Are Financial Deepening and Economic Growth Causally Related? Another Look at the Evidence. International Economic Journal, 13, 19-35.
Darrat, A. F. (1999). Are Financial Deepening and Economic Growth Causally Related? Another Look at the Evidence. International Economic Journal, 19-35.
Dawson, P. J. (2003). Financial development and growth in economies in transition. Applied Economics Letters, 10(13), 833-836.
Demetriades, P. O., & Hussein, K. A. (1996). Does financial development cause economic growth? Time-series evidence from 16 countries. Journal of Development Economics, 51, 387-411.
Engle, R. F., & Granger, C. (1987). Cointegration and Error Correction: Representation, Estimation and Testing. Econonetrica, 55(2), 251-276.
Fase, M., & Abma, R. (2003). Financial environment and economic growth in selected Asian countries. Journal of Asian Economics, 14, 11–21.
Fatima, A. M. (2004). Does Financial Development Cause Economic Growth? An Empirical Investigation Drawing On the Moroccan Experience. Lancaster University Management School Working Paper.
Fethi, S., & Katircioglu, S. (2015). The role of the financial sector in the UK economy: evidence from a seasonal cointegration analysis. Economic Research-Ekonomska Istraživanja, 28(1), 717-737.
Ghali, K. H. (1999). Financial Development and Economic Growth: The Tunisian Experience. Review of Development Economics, 3(3), 310–322.
Ghirmay, T. (2004). Financial Development and Economic Growth in Sub-Saharan African Countries: Evidence from Time Series Analysis. African Development Review, 16(3), 415–432.
Goldsmith, R. W. (1969). Financial Structure and Development as a Subject for International Comparative Study. The Comparative Study of Economic Growth and Structure, 114 - 123).
Granger, C. (1980). Testing for causality: A personal viewpoint. Journal of Economic Dynamics and Control, 2, 329-352.
Gurley, J. G., & Shaw, E. S. (1967). Financial Structure and Economic Development. Economic Development and Cutural Change, 15(3), 257-268.
Habibullah, M. S., & Eng, Y.-K. (2006). Does Financial Development Cause Economic Growth? A Panel Data Dynamic Analysis for the Asian Developing Countries. Journal of the Asia Pacific Economy, 11(4), 377-393. doi:10.1080/13547860600923585
Habibullah, M. S., & Eng, Y.-K. (2006). Does Financial Development Cause Economic Growth? A Panel Data Dynamic Analysis for the Asian Developing Countries. Journal of the Asia Pacific Economy, 377-393.
Habibullah, M. S., & Eng, Y.-K. (2007). Does Financial Development Cause Economic Growth? A Panel Data Dynamic Analysis for the Asian Developing Countries. Journal of the Asia Pacific Economy, 11(4), 377-393. doi:10.1080/13547860600923585
Hargreaves, C. P. (1994). Non-Stationary Time Series Analysis and Cointegration (Advanced Texts in Econometrics). Oxford: Oxford University Press.
Harris, R. (1995). Cointegration Analysis in econometric modelling. London: Printice Hall.
Hill, R. C., Griffiths, W. E., & Lim, G. C. (2012). Principles of Econometrics (4th ed.). Wily and Sons.
Hye, Q. M. (2011). Financial development index and economic growth: empirical evidence from India. The Journal of Risk Finance, 12(2), 98 - 111.
Jalilian, H., & Kirkpatrick, C. (2002). Financial Development and Poverty Reduction in Developing Countries. International Journal of Finance and Economics, 7, 97–108.
Johansen, S. (1988). Statistical analysis of cointegration vectors. Journal of Economic Dynamics and Control, 12(2), 231-254.
John, A. K. (2014). Financial Deepening and Economic Growth: Evidence from Nigeria. International Journal of Economics, Commerce and Management, 2(11).
Jung, W. S. (1986). Financial Development and Economic Growth: International Evidence. Economic Development and Cultural Change, 34(2), 333-346.
Kar, M., Nazlıoğlu, Ş., & Ağır, H. (2011). Financial development and economic growth nexus in the MENA countries: Bootstrap panel granger causality analysis. Economic Modelling, 28, 685–693.
Kenourgios, D., & Samitas, A. (2007). Financial Development and Economic Growth in a Transition Economy: Evidence for Poland. JOURNAL OF FINANCIAL DECISION MAKING, 7(3).
King, R. G., & Levine, R. (1993). Finance, entrepreneurship and growth: Theory and evidence. Journal of Monetary Economics, 32(3), 513–542.
Lean, H. H., & Song, Y. (2009). The domestic savings and economic growth relationship in China. Journal of Chinese Economic and Foreign Trade Studies, 2(1), 5 - 17.
Levine, R. (2005). Finance and Growth: Theory and Evidence. Handbook of Economic Growth, 1, 865–934.
Luintel, K. B., & Khan, M. (1999). A quantitative reassessment of the finance–growth nexus: evidence from a multivariate VAR. Journal of Development Economics, 60, 381–405.
Luintel, K. B., & Khan, M. (1999). A Quantitative Reassessment of the Finance–growth Nexus: Evidence From A Multivariate VAR. Journal of Development Economics, 60, 381–405.
Masoud, N., & Hardaker, G. (2012). The impact of financial development on economic growth Empirical analysis of emerging market countries. Studies in Economics and Finance, 29(3), 148 - 173.
McKinnon, R. I. (1973). Money and Capital in Economic Development. Washinton DC: The Brookings Institution.
Mishkin, F. S. (2007). The Economics of Money, Banking and Financial Markets (8th ed.). Boston: Peason.
Neimke, M. (2004). Financial Development and Economic Growth in Transition Economies. IEE Working Papers, 173.
Neusser, K., & Kugler, M. (1998). Manufacturing Growth and Financial Development: Evidence from OECD Countries from OECD Countries. The Review of Economics and Statistics, 638-646.
Nyasha, S., & Odhiambo, N. M. (2015). Banks, stock market development and economic growth in South Africa: a multivariate causal linkage. Applied Economics Letters, 22(18), 1480-1485.
Odedokun, M. (1996). Alternative econometric approaches for analysing the role of the financial sector in economic growth: Time-series evidence from LDCs. Journal of Development Economics, 119-146.
Odhiambo, N. M. (2009). Finance-Growth Nexus and Inflation Dynamics in Kenya: An Empirical Investigation. Savings and Development, 33(1), 7-25.
Office for National Statistics. (2016). Key Economic Time Series Data. Retrieved from www.ons.gov.uk: http://webarchive.nationalarchives.gov.uk/20160105160709/http://www.ons.gov.uk/ons/site-information/using-the-website/time-series/index.html
Patrick, H. T. (1966). Financial Development and Economic Growth in Underdeveloped Countries. Economic Development and Cultural Change, 14(2), 174-189.
Petkovski, M., & Kjosevski, J. (2014). Does banking sector development promote economic growth? An empirical analysis for selected countries in Central and South Eastern Europe. Economic Research-Ekonomska Istraživanja, 27(1), 55-66.
PRADHAN, R. P. (2009). The Nexus between Financial Development and Economic Growth in India: Evidence from Multivariate VAR Model. International Journal of Research and Reviews in Applied Sciences, 1(2).
Rachdi, H., & Mbarek, H. B. (2011). The Causality between Financial Development and Economic Growth: Panel Data Cointegration and GMM System Approaches. International Journal of Economics and Finance, 3(1).
Robinson, J. (1952). The Rate of Interest and Other Essays. London: MacMillan.
Rousseau, P., & Wachtel, P. (1998). Financial Intermediation and Economic Performance: Historical Evidence from Five. Journal of Money, Credit and Banking, 30(4), 657-678.
Saci, K., Giorgioni, G., & Holden, K. (2009). Does financial development affect growth? Applied Economics, 41(13), 1701-1707.
Samargandi, N., Fidrmuc, J., & Ghosh, S. (2013). Is the Relationship between Financial Development and Economic Growth Monotonic for Middle Income Countries? Economics and finance working paper series / Brunel University West London, Brunel Business School, 13-21.
Schumpeter, J. A. (1934). The Theory of Economic Development; an inquiry into profits, capital, credit, interest, and the business cycle. Harvard Economic Studies.
Sehrawat, M., & Giri, A. (2015). Financial development and economic growth: empirical evidence from India. Studies in Economics and Finance, 32(3), 340 - 356.
Shabri, M., & Majid, A. (2008). Does Financial Development Matter For Economic Growth In Malaysia? An ARDL Bound Testing Approach. Journal of Economic Cooperation, 61-82.
Shan, J. Z., Moris, A. G., & Sun, F. (2001). Financial Development and Economic Growth: An Egg and Chicken Problem? Review of Internatioinal Economics, 9(3), 443-454.
Shan, J., & Jianhong, Q. (2006). Does Financial Development ‘Lead’ Economic Growth? The Case of China. Annals of Economics and Finance, 1, 197–216.
Shan, J., & Morris, A. (2002). Does Financial Development 'Lead' Economic Growth? International Review of Applied Economics, 16(2), 153-168,.
Shaw, E. (1973). Financial deepening in economic development. New York: Oxford University Press.
Sinha, D., & Macri, J. (2001). Financial development and economic growth: The case of eight Asian countries. Munich Personal RePEc Archive.
Tyavambiza, T., & Nyangara, D. (2015). Financial and Monetary Reforms and the Finance-Growth Relationship in Zimbabwe. International Journal of Economics and Financial Issues, 5(2), 590-602.
Tyler, G. (2015). Financial Services: contribution to the UK economy. House of Common Library.
Uwakaeme, O. (2015). Economic Growth in Nigeria: An Empirical Investigation of Determinants and Causal Relationship (1980 – 2012). American Journal of Economics, 5(1), 9- 20.
Vazakidis, A., & Adamopoulos, A. (2011). Financial Development and Economic Growth: An Empirical Analysis for the UK. European Research Studies, 14(2).
Wood, A. (1993). Financial Development And Economic Growth In Barbados: Causal Evidence. Savings and Development, 17(4), 379-390.
World Economic Forum. (2011). The Financial Development Report 2011.
www.imf.org. (2015). Financial System Soundness. Retrieved from www.imf.org: http://www.imf.org/external/np/exr/facts/banking.htm
Published
2021-01-01
Section
Articles
How to Cite
Wesiah , S., & Onyekwere, S. C. (2021). The Relationship Between Financial Development and Economic Growth in The United Kingdom: A Granger Causality Approach. Quantitative Economics and Management Studies, 2(1), 47-71. https://doi.org/10.35877/454RI.qems258