The direction of causality between financial development and economic growth

This paper employs the Geweke decomposition test on pooled data of 109 developing and industrial countries from 1960 to 1994 to examine the direction of causality between financial development and economic growth. The paper finds that (1) financial development generally leads to economic growth; (2) the Granger causality from financial development to economic growth and the Granger causality from economic growth to financial development coexist; (3) financial deepening contributes more to the causal relationships in the developing countries than in the industrial countries; (4) the longer the sampling interval, the larger the effect of financial development on economic growth; (5) financial deepening propels economic growth through both a more rapid capital accumulation and productivity growth, with the latter channel being the strongest. (C) 2003 Elsevier Science B.V. All rights reserved.