The impact of financial instablity on economic growth: evidence of emerging market economies

The aim of this study is to investigate the impact of financial instability on economic growth. Starting from the hypothesis that financial instability impacts economic growth negatively, first the definition of instability are made and than focused on the causes of instability to understand a conceptual framework better. In order to test the relationship between economic growth and financial instability the econometric model has been created by panel data analysis methods. Financial instability index is used for the empirical model. The risk and the vulnerability of the financial system has been determined with this approach. The main indicators which have been used at the emprical part are; macroeconomic indicators and a composite index of financial indicators which is crucial to estimate soundness and stability of the financial system. The relationship between financial instability and economic growth in emerging market economies are discussed in this context. Because in a fragile financial system it is more than possible to occur potential systemic shocks which have systemic effects. If the financial system is not strong enough to face with any shocks or not qualified to isolate the negative effects of the financial crisis, it results with negative economic growth rates. In this study, non-stationary dynamic panel data analysis has been used to investigate not only examine the heterogeneity of the variables but also to consider cross-section dependency between each units. The second-generation panel unit root tests utilized in this model, the long-term regression coefficients forecasted and panel causality analysis were used to determine the direction of the relationship between the economic growth and financial instability. The empirical findings of the study support the hypothesis which assumes that financial instabilityhas adverse effects on economic growth. Keywords: Financial Instability, Economic Growth, Emerging Market Economies, Financial Instability Index, Panel Data Analysis, Panel Causality Analysis.