Does Finance Matter for Growth? What the Data Show

This paper analyses the relationship between financial development (as measured by expansion of domestic credit to private sector relative to GDP) and growth for a sample of 65 less developed countries over a long period, 1980-2006. Using causality tests at various lag-orders we find a strong evidence of mutual causation. We have used alternative dynamic panel data models to estimate the relationships between the two. While the mean group model suggests no relationship in either direction, the pooled mean group model and dynamic fixed effect model show two opposite long-term relationships: finance-to-growth relationship is negative whereas growth-to-finance link is positive