Financial Development and Economic Growth: A VECM Approach

Existing literature has dealt inadequately with the causality issue in the link between financial development and economic growth. The paper investigates the empirical link between financial development and economic performance for the case of the small island developing state of Mauritius, using a unique time series data set for the period 1952-2004. The analysis uses a Vector Error Correction Model (VECM) framework, which allows for dynamic and feedback effects. The results suggest that financial developments have been contributing to the output level of the economy in both short- and long-run. It, thus, highlights the economic importance of financial development and provides new evidence for the case of island economies using recent cointegration approach.