Do banking sector and stock market development matter for economic growth?
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Do banking sector and stock market development matter for economic growth? Joshua Cave1 · Kausik Chaudhuri1 · Subal C. Kumbhakar2 Received: 20 August 2018 / Accepted: 4 April 2019 © Springer-Verlag GmbH Germany, part of Springer Nature 2019
Abstract Financial development as a concept is multifaceted with no clear measurement or definition. Inference via individual proxies may result in an incomplete understanding of the relationship between financial development and economic growth, since sole proxies are unlikely to capture the true capacity of financial development. To address this issue, this paper utilizes a multiple indicators multiple causes (MIMIC) model to create a more complete measure of financial development. In doing this, we treat banking sector and stock market developments as two latent indicators of financial development and use the MIMIC model to predict them which are used as their proxies. Using data from 101 countries over the period 1990–2014, we use the predicted values of the two latent variables as regressors, among other controls, in the growth regression. We find a robust negative relationship between banking sector development and economic growth, whereas the effect of stock market development on economic growth is positive up to a threshold after which the effect becomes negative. Keywords Financial development · Economic growth · Multiple indicators multiple causes JEL Classification C22 · G20 · O40
We would like to thank Bertrand Candelon, Editor-in-Chief and an anonymous referee for helpful comments. * Subal C. Kumbhakar [email protected] Joshua Cave [email protected] Kausik Chaudhuri [email protected] 1
Department of Economics, Leeds University Business School, Leeds LS2 9JT, UK
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Department of Economics, SUNY Binghamton, Binghamton, NY 13902, USA
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1 Introduction The role of financial development on economic growth is a widely researched area in the endogenous growth literature. Levine (2005) advocated that financial systems facilitate economic growth through five core functions by: (1) easing the exchange of goods and services through the provision of financial payments, (2) pooling and mobilizing savings from investors, (3) collecting ex-ante information about future investments and allocating capital, (4) monitoring investments and carrying out corporate governance and (5) facilitating trading, diversification and the management of risk. However, both theoretical and empirical research disputed the relative merits of financial development on economic growth. Miller (1998), for example, recommended that the issue is too obvious to even consider, and Lucas (1988) opined that the role of financial systems is overstated. Recent empirical studies have also emphasized on the vanishing effect of financial depth on economic growth (Demetriades and Law 2006; Rousseau and Wachtel 2002, 2011).1 Two broad views, namely the banking sector and the stock market development, were considered while analyzing the role of financial development
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