An Empirical Reassessment of the Relationship between Finance and Growth

This paper re-examines the empirical relationship between financial development and economic growth. It presents evidence based on an updated data set, a variety of econometric methods and two standard measures of financial development: the level of liquid liabilities of the banking system and the amount of credit issued to the private sector by banks and other financial institutions. There are two main findings.First, in contrast with the recent evidence of Levine, Loayza and Beck (2000), cross section and panel data instrumental variables regressions reveal that financial development and economic growth are correlated but financial development does not cause economic growth. Second, there is evidence that this relationship is quite heterogeneous across countries. Using a procedure appropriately designed to estimate long-run relationships in a panel with heterogeneous slope coefficients, there is no clear indication that finance spurs economic growth.