Financial deepening, trade openness and economic growth in Latin America and the Caribbean

This contribution investigates the causal interactions between financial deepening, trade openness and economic growth in 13 Latin American and Caribbean countries. We construct a composite indicator for financial deepening and use it to detect Granger causality within a modified Vector Autoregressive/Vector Error Correction Model (VAR/VECM) framework. We find almost no evidence for the popular hypothesis of finance-led growth. Evidence of bidirectional finance-growth causality is stronger but mostly instable in the long run. Most results indicate a demand following or insignificant causal relationship between finance and growth. There is also no evidence that finance indirectly induces growth via the channel of trade openness. Hence, policies that prioritize financial and trade sector development cannot be supported.