Economic Growth and Financial Depth: Is the Relationship Extinct Already?

26 Pages Posted: 27 Oct 2005

See all articles by Peter L. Rousseau

Peter L. Rousseau

Vanderbilt University - Department of Economics

Paul Wachtel

New York University - Stern School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: September 12, 2005

Abstract

Although the finance-growth nexus has become firmly entrenched in the empirical literature, studies that question the strength of the empirical results have appeared and seem to have become more frequent as well. In this paper we reexamine the core crosscountry panel results that established the relationship between financial depth and growth rates. We examine the sensitivity of the core result to changes in time period and variation in the sample of countries included.

We find that the finance-growth relationship in not as strong with more recent data as it was in the original studies with data for the period from 1960 to 1989. We offer two possible explanations. First, financial depth may have had greater value as a shock absorber in the 1970s and 80s, decades characterized by worldwide nominal shocks.

Second, the spread of financial liberalization in the 1980s may have led to increasing financial depth in countries that lacked the legal or regulatory infrastructure to successfully exploit financial development.

We use a rolling regression technique to see which countries provide stronger support for the finance growth relationship. Among poorer counties, the relationship is positive but imprecisely measured and among very rich countries it is absent. However, there is clear indication that financial deepening increases growth among the countries with real GDP per capita between $3,000 and $12,000 (1995 US). In a word, we find the widely accepted effect of finance on growth to be still present but fragile.

Keywords: finance-growth nexus, rolling regression, robustness, cross-country growth

JEL Classification: E44, G10, O40

Suggested Citation

Rousseau, Peter L. and Wachtel, Paul, Economic Growth and Financial Depth: Is the Relationship Extinct Already? (September 12, 2005). Available at SSRN: https://ssrn.com/abstract=825744 or http://dx.doi.org/10.2139/ssrn.825744

Peter L. Rousseau (Contact Author)

Vanderbilt University - Department of Economics ( email )

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Paul Wachtel

New York University - Stern School of Business ( email )

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HOME PAGE: http://www.stern.nyu.edu/~pwachtel