Nonlinear Approach to Financial Development – Economic Growth Nexus: Evidence from Developed and Developing Countries

Abstract

While there is a general consensus among economists on the fundamental role that financial markets play in fostering economic growth, theoretical and empirical work supporting this idea is still very much in progress. This thesis aims to shed light on this issue by providing new empirical evidence using several relevant macroeconomic variables that are expected to affect the finance-growth relationship as state variables. Namely, in this study financial development - economic growth nexus is investigated. To this end, Hansen (1999)’s Panel Threshold Regression Model for a panel of 56 countries is applied over the period 1967-2016. The estimation results reveal that financial development has a positive and significant effect on economic growth in all developing countries. However, for developed countries, financial development negatively affects growth, except for the case when growth is used as state variable. This study suggests that it is crucial for the policymakers to know the threshold values. If the optimal level of finance is known, the policymakers can implement policies that can prevent the detrimental effects of the too much finance on the economy.