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Does Financial System Development Cause Economic Growth?

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Economic growth involves a change in the way goods and services are produced over time. It is not only an increase in the capacity of an economy to more produce goods and services in order to earn more money. Economic growth is a long-term expansion of the productive potential of the economy. Sustained economic growth may lead to an increase in living standards and rising in employment. Economic growth is measured in terms of gross national product (GNP) or gross domestic product (GDP).
A financial system is the set of institutions and markets that help in the transfer of excess funds from people having surplus funds to those in need of credit .The financial system has a vital role in promoting and developing the economy of a country and meeting …show more content…

Since the past decades, there have been a variety of studies which have emphasized on the relationship between development in the financial sector and the economic growth and also on the bi directional causality. This lead to the question: Does the financial system development cause economic growth or does economic growth cause or encourage financial system development.
1.1. Does financial system development cause economic growth?

This question has been examined widely and explicitly by many researchers around the world. Financial system development causes economic growth follows the supply–leading hypothesis.

A country where financial institutions are not facilitating financial activities in the domestic and international economy may have to face many problems, and that ultimately affects the economic development of the country. Efficient financial system helps a country to achieve the following objectives:

• Transfer of financial resources: Obtaining funds from the surplus holders such as household individuals, business firms, public/private sector, government etc. is an important role played by financial …show more content…

They used the panel unit root analysis and co integration analysis for ten developing countries. The results showed a clear support for the hypothesis that there is a single equilibrium relation between financial depth and growth.
1.2. Does economic growth cause or encourage financial system development?

Financial development resulting from economic growth is referred to as the demand following hypothesis. This implies that a boost in the economy would increase the need for financial services example loans, and business card and thus causing a demand for financial system development.
1.2.1. Literature review
In contrast to the school of thought who affirms that financial system development leads to economic growth there are other economists like Adams (1819); Robinson (1952) and Hicks (1969) who have a distinctly opposite view.

They argue that a developed financial system is the results of the financial services which arise as the economic growth

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