Financial development and economic growth in Ethiopia: A dynamic causal linkage

Abstract

This paper investigates the dynamic causal linkage between bank-based financial development and economic growth in Ethiopia during the period from 1980 to 2014. The study includes savings and investment as intermittent variables in an attempt to address the omission of variable bias – thereby creating a multivariate Granger-causality model. Using the newly developed autoregressive distributed lag bounds testing approach to cointegration and the error-correction model-based causality model, the study finds that in the short run, both financial development and economic growth Granger-cause each other in Ethiopia. However, in the long run, there is unidirectional Granger-causality from bank-based financial development to economic growth. The study, therefore, recommends that policies aimed at enhancing both economic growth and financial development should be pursued in the short run. However, in the long run, policies that target the development of the banking sector should be prioritised in order to ensure a sustained growth path.