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The Causal Relationship Between Financial Development And Economic Growth

725 words - 3 pages

In his paper, Jung conducts tests of causality based on Granger’s notion of causality between two time series, selecting 56 counties having at least 15 annual observations on all the variables. Developed countries account for 19 of the overall 56 countries selected. The first part of the paper explains the econometric test of Granger’s causality, while the second examine causality relations between financial and economic development.
Jung then refers to Patrick’s identification of two possible patterns in the causal relationship between financial development and economic growth. The first, called “demand-following”, growth generates an expansion of financial development, as the real side of ...view middle of the document...

First, a test of X causal effect on Y should fail to detect the effect contemporaneous innovations in X on Y. Secondly some countries could have undergone structural changes during the sample period. Finally, the assumption underlying the test that the X and Y can be represented as covariance-stationary time series may not be valid.
When choosing proxies of financial development, Jung states the countries tend to differ in their institutional environment and may have different financial structure, facts making the measurement of financial development problematic. The author goes on to employ two alternative proxies. The first is the currency ratio, defined as the ratio of currency to the narrow definition of money (M1), the sum of currency and demand deposit, as a proxy for the complexity of the financial structure. The second is the ratio of M2, a broader definition of money, to nominal GDP, as a monetization variable and is designed to show the real size of financial sectors. The second ratio should, according to Jung, increase over time if the financial sector develops faster the real sector, and vice versa.
Jung runs four regressions for each country, two for the case of the currency ratio (C) and income and two for the monetization (M) and income. Also, as...

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