Financial development and economic growth in Turkey: causality analysis

Financial sector is the major channel to mobilize savings from individuals to investors. It is accepted that, a well functioning financial sector positively affects the economic growth. The intermediation function that is beyond being a simple fund transfer from te savers to investors, contributes to increase in efficiency by allocating resources to the most productive investments. Ever since 1970?s the relationship between financial development and economic growth has remained an important issue of debate. The direction of causality between financial sector development and economic growth, in particular, has attracted a great deal of attention. According to supply-leading hypothesis financial development leads to economic growth, however demand following hypothesis asserts that the direction of the relationship runs from economic growth to financial development. This study examines the causal relationship between financial development and economic growth in Turkey for the period 1986:1-2006:4, using techniques of unit root and cointegration analysis. The empirical findings show that, in the short-run, causality runs from economic growth to financial development and support the demand-following hypothesis. On the other hand the findings, in the long run, show a weak link between financial development and economic growth in Turkey. Keywords: Financial Development, Economic Growth, Causality, Unit Root, Cointegration.