Financial Development and Economic Growth: The Case of Nigeria

ABSTRACT: The link between the financial development and economic growth is a widely investigated area in economic literature. Most cross-country studies established a positive relationship between financial development and economic growth pioneered by McKinnon and Shaw (1973). However, empirical research in low income countries, especially in most African and Latin American countries did not support the positive link hypotheses despite the liberalization of their financial markets. This raised questions on the strength of the relationship as large capital flows encouraged by financial liberalization made the countries more prone to crises exerting even negative impacts on such economies. This research seeks to explore any possible relationship between financial development and economic growth in Nigeria within a vector autoregressive (VAR) framework and also study the direction of causation. Following Demirguc-Kunt and Levine (1979) different channels of financial development are studied by distinguishing between the banking and the stock market development. The empirical results indicate that the banking sector plays an important role in the long-run contributing positively to economic growth while the stock market exerts no impact to long-run economic growth. Based on the bivariate models there is strong evidence of a unidirectional Granger-causality relationship from money supply to economic growth and a weak support for other financial development variables. Considering higher dimensional system, there is strong evidence of a feedback effect among economic growth and financial development variables over the sample period. Keywords: Financial Development, Economics Growth and Nigeria. …………………………………………………………………………………………………………………………