This study explores the relationship between financial growth and economic development in India using time series data over the period 1950-2007. The majority of the previous studies on this subject have used cross-sectional data, which may not address country specific issues. In addition, many studies used either OLS technique of estimation or bi-variate causality test and may, therefore suffer from the omission-of variable bias. This study attempts to examine the dynamic relationship between financial growth and economic development by including a range of financial variables like, quasi money for monetization, domestic credit for financial intermediation activities and bank asset for financial intermediary institutions. The casual relationship between economic development and financial growth indicators was examined with the help of Granger-Causality procedure based on Unrestricted Vector Auto Regression using the error correction term. The result from the cointegration tests indicates that financial development has a long-run equilibrium with economic growth. The financial sector and real sector move and evolve together in the same direction. The error correction model suggests that, in the short-run, the output variable is the only effective adjustment factor in the system that responds to the fluctuations of financial measures and domestic capital formation. On the other hand, the response of financial intensities and investments are sluggish adjustments that correct the deviation from equilibrium. In nutshell, this study shows that India’s financial development and economic growth are positively correlated; the process of economic development is not sustainable without the contributions of the financial sector and vice versa.
Table of Contents
Chapter 1
Background of Finance-Growth Nexus
Chapter 2
Trends of financial growth and economic development in India
Finance-Growth Nexus: The Indian Experience
Objective of the study
Chapter 3
Literature Review
Chapter 4
Data Description
Chapter 5
Theory, Empirical Model and Methodology
Empirical model specification and estimation technique
Stationarity Test
Cointegration Test
Vector Error Correction Estimate
Granger Causality using Unrestricted VAR
Chapter 6
Results and Interpretations
Stationarity Test
Cointegration Test
Vector Error Correction Estimate
Granger Causality using Unrestricted VAR
Chapter 7
Conclusion
Policy Implication
Limitation and Scope of study
Research Objectives and Themes
This thesis investigates the dynamic causal relationship between financial development and economic growth in India from 1950 to 2007, aiming to determine whether financial growth leads to economic development or vice versa, while accounting for structural reforms.
- Analysis of the finance-growth nexus within the Indian economic context.
- Use of time-series econometric techniques including cointegration and vector error correction models.
- Evaluation of the impact of financial sector reforms post-1991.
- Investigation of causality directions across three distinct periods: pre-reform, post-reform, and the overall period.
Excerpt from the Book
Background of Finance-Growth Nexus
One of the most debatable topics in development economics literature is the direction of causality between financial growth and economic development. The discussion dates back to 1911 when Joseph Schumpeter argued that the services provided by financial intermediaries - i.e. mobilizing savings, evaluating projects, managing risk, and facilitating transactions - stimulate technological innovation and economic development. Other early studies were undertaken by Goldsmith (1969), McKinnon (1973), and Shaw (1973) who stressed the connection between a country's financial superstructure and its real infrastructure. Economists like Robert Solow advocated the role of capital, labor and technology as the sources of growth and ignored any possible role of the financial sector. Similarly, Lucas (1988), and Robinson (1952) found that the role of finance is considerably over-stressed. Levin and King (1993) emphasized in their papers that financial development is strongly associated with GDP growth, the rate of capital accumulation and improvement in efficiency. However, Luintel and Khan (1999) have a different point of view; they found that there is a causal relationship between financial growth and economic development.
There are many differences among economists regarding the Finance-Growth nexus in the development literature. They can be grouped in three broad categories: Supply Leading approach (finance-led growth), Demand Following (growth-led finance) and Cautionary or Feedback approach. According to the Supply Leading approach, financial activity is a major determinant for economic development. The argument is that well functioning financial intermediations provide a much needed platform for users and savers in channeling surplus and deficits, which helps to efficiently allocate resources in the economy. Secondly, the demand following approach suggests that the financial sector development is the result of economic growth. In other words, economic development generates a demand for more financial services in the economy. Finally, the Feedback approach suggests a two-way causal relationship between financial development and economic growth.
Summary of Chapters
Chapter 1: Provides an introduction to the central debate surrounding the causality between financial growth and economic development in the field of economics.
Chapter 2: Details the economic growth history of India, including the shifts from pre-reform state-controlled models to post-1991 liberalization and the current structure of the Indian financial system.
Chapter 3: Reviews the extensive literature on the dynamic interactions between financial development and economic growth, categorizing existing studies and theories.
Chapter 4: Describes the data set used, including sources from the Reserve Bank of India and IMF, and defines the independent and dependent variables used in the empirical models.
Chapter 5: Outlines the theoretical framework, the empirical model specifications, and the econometric methodology, including unit root, cointegration, and causality tests.
Chapter 6: Presents the empirical findings from the stationarity, cointegration, and Granger causality tests, offering interpretations of the results for different time periods.
Chapter 7: Concludes the study by summarizing the findings, offering policy implications based on the analysis, and acknowledging the limitations of the research.
Keywords
Finance-Growth Nexus, Economic Development, India, Financial Liberalization, Causality, Cointegration, Error Correction Model, GDP, Capital Formation, Banking Sector, Vector Autoregression, Financial Infrastructure, Structural Reforms, Unit Root, Time-Series Analysis
Frequently Asked Questions
What is the primary focus of this thesis?
The thesis focuses on examining the causal relationship between financial development and economic growth within the Indian economy over the period from 1950 to 2007.
What are the central themes discussed in the work?
The central themes include the debate between supply-leading and demand-following financial growth, the impact of economic reforms in India, and the role of financial intermediaries in resource allocation.
What is the core objective of the study?
The objective is to empirically determine the direction of causality between finance and growth in India, specifically investigating whether financial development triggers economic growth or if economic development drives the demand for financial services.
Which scientific methods are employed?
The study utilizes time-series econometric techniques, including Augmented Dickey-Fuller (ADF) and Phillip-Perron unit root tests, Johansen cointegration tests, and Vector Error Correction Models (VECM) to perform Granger causality analysis.
What is covered in the main body of the work?
The main body covers the theoretical background, a review of existing literature, a detailed description of the data, the empirical modeling strategy, and a rigorous analysis of the test results for different economic regimes in India.
How would you characterize this work using keywords?
The work is best characterized by terms such as Finance-Growth Nexus, India, Cointegration, Granger Causality, Economic Development, and Financial Liberalization.
How do the findings differ between the pre-reform and post-reform periods?
The study finds a significant shift in causality after the 1991 reforms, moving from a period where financial indicators had weaker impacts to a post-reform era where a bidirectional relationship or stronger causal links are more evident.
Why did the author include 'capital formation' as a variable?
Capital formation was included as a link variable to capture the dynamic interaction between financial growth and economic development, helping to avoid simultaneity bias in the model.
What policy implications does the author suggest?
The author suggests further financial liberalization, including the reduction of state ownership in banks, strengthening corporate governance, and fostering the development of the corporate bond market to improve financial system efficiency.
- Quote paper
- Manoj Dora (Author), 2009, Finance-Growth Nexus: Evidence from Indian Economy using Causality Co-Integration Test based on Error Correction Model, Munich, GRIN Verlag, https://www.grin.com/document/137673
