The Role Of Financial Development On Economic Growth In Ethiopia

Abstract

Economic development is the purpose of the every country in the world. But in an accurate approach to uplift an economy is more a clandestine than a fact. Many economist have been agreed an economic growth depends upon the financial development enhancement, efficiency and an independence of financial sector. With this impulse, this paper has attempted to attain two paramount objectives: examining the effect of financial development on economic growth and investigating the effect of other variables which were supposed and simultaneously supported by substantial body of literature to have significant effect on economic growth. The study investigates empirically the causal linkage between private credit, foreign aid and financial development of Ethiopia. The study used time series data from 1981-2017 in order to examine the association ship among variables. It employs Johansen for co-integration and popular Vector Error Correction Model (VECM) for long-run equilibrium relationship and causality test in order to find the causality of short run as well as long run among these variables and to assess how the financial sector contributes to growth. The result revealed that there is the long-run equilibrium relationship among GDP, Private Credit, and Foreign Aid for Ethiopia. On the contrary, the findings shows that there is no causality between foreign aid to GDP. This study also reveals that there is short-run causality from private credit to GDP that indicates private credit access to enhance the productive capacity of individuals, firms and enhances their potential to grow. The study concludes that financial sector development has a growth stimulating effect on Ethiopian economy.