The nonlinear relationship between financial development and economic growth revisited

This paper presents a simple endogenous growth model in which the financial sector improves the efficiency of the savings transformation into investment. The model suggests that multiple endogenous growth paths can exist and the possibility of non-linear relationship between financial development and economic growth in the long-run. The empirical estimation realized using PSTR (Panel Smooth Threshold Regression) models on 71 countries over the period 1960-2006, confirms the theoretical threshold effects. Furthermore, our empirical results show that the relationship between financial development and growth is positive for low level of financial development, but become indeterminate in financially developed economies. These results are confirmed using the GMM dynamic panel technique.