Modelling the effects of financial sector functions on economic growth in a developing country: a cointegration and error correction approach

This study develops proxies for each of Levine's (1997) five functions of the financial sector, and models the relationship between these functions and economic growth using methods that more accurately conform to theory, and which broaden our understanding of the mechanisms through which the financial sector impacts on growth. Our analytical models provide for inferences about the relative importance of each of the functions of the financial sector and cointegration and error correction methods are used to distinguish between the long and short-run impacts of financial sector intermediation on economic growth. Our results suggest that if financial sector reforms are to be more effective, greater focus has to be placed on mechanisms through which savings mobilization can be maximized, and the allocation of resources to productive uses can be facilitated. Policymakers should also not expect immediate results from such reforms, as although the functions of the financial sector were shown to have statistically significant long-run impacts on GDP, none of the functions had significant short-term effects on growth.