Academic journal article IUP Journal of Applied Economics

Bound Testing Approach for Cointegration and Causality between Financial Development, Trade Openness and Economic Growth in Bulgaria

Academic journal article IUP Journal of Applied Economics

Bound Testing Approach for Cointegration and Causality between Financial Development, Trade Openness and Economic Growth in Bulgaria

Article excerpt

The purpose of this study is to examine the relationship between financial development, trade openness and economic growth in Bulgaria using cointegration analysis and Granger causality technique. The bounds testing approach to cointegration is used to establish the existence of long-run relationship between financial development, trade openness and economic growth. An augmented form of Granger causality analysis is implemented to identify the direction of causality among the variables both in the short run and the long run. The results from Granger causality tests based on multivariate error-correction model suggest unidirectional causation from financial development and trade openness to economic growth, as well as unidirectional causation from financial development and economic growth to trade openness in the long run. In the short run, a bidirectional causality between financial development and trade openness and a unidirectional causality running from economic growth to financial development is observed at 1% significance level.

(ProQuest: ... denotes formulae omitted.)

Introduction

In economics, the impact of financial markets development on economic growth has always been an important issue. In international literature, although many studies have been conducted since the 1900 to observe the relationship between financial development and economic growth, each study had found meaningful results only for its own period. Studies undertaken to examine the relationship between financial development and economic growth date back as far as to the works of Schumpeter (1912) and Hicks (1969). For instance, Schumpeter (1912), nine decades ago, stressed the role of the banking sector as a financier of productive investments and thus as an accelerator of economic growth.

Although there is a consensus among economists regarding the impact of financial development on economic growth, they do not always share the same ideas when it comes to the direction of causality, which means whether financial development causes economic growth or vice versa. For instance, Schumpeter (1912) and Hicks (1969) support that financial development causes financial growth. On the other hand, Robinson (1952) argues that under the same type of financial regulations, economic growth creates a demand and financial system gives an automatic response to this demand, which in turn, causes financial development (Levine, 1997).

Later works include those of Greenwood and Jovanovic (1990), Bencivenga and Smith (1991), Levine (1991), and Saint-Paul (1992), which involved theoretical models, wherein efficient financial markets improve the quality of investment and enhance economic growth.

In the Greenwood and Jovanovic (1990) model, the primary task of financial intermediaries is to channel funds to the most profitable investments they can identify by using information that they have gathered and analyzed. The higher rate of return earned on capital promotes economic growth, which in turn, provides the means to implement costly financial structures.

The relationship between openness and economic growth has been fully analyzed by a large number of empirical papers. In the traditional models of international trade, openness to trade increases the value of the total production in the economy. In an open economy, technology and knowledge may be transferred through trade, and there is a shiftin resources toward the sectors that draw upon the abundant factor, and the value of total production increases. An increase in total output, following a movement from autarky to free trade, can be also found in some models of economies of scale with monopolistic competition (Krugman, 1979). In the neoclassical model Harrod-Domar (Harrod, 1939; and Domar, 1946), where capital is the sole factor of production, trade liberalization has positive growth effects. Openness has been considered one of the main determinants of economic growth in developing countries. …

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