Abstract:
In this study an effort is made to empirically examine the long run causal relationship between
financial development and economic growth Ethiopia by employing ARDL Bounds Testing model
technique. To this effect, annual data running from 1984-2021 is used for each variable entered the
model: Real GDP growth and financial development as variables of interest, and Consumer Price
Index, Trade openness and Remittances as control variables. The Bound test results revealed that
there is a cointegrating relationship between economic growth, financial development, and other
vector variables. Following evidence of cointegrating among the variables, financial development has
a positive significant long run impact on the economic growth and both the magnitude and sign of co
integrating coefficient of financial development to the economic growth is reasonable and as
expected. More specifically, a 1-unit permanent increase in financial development is associated with
136.13 units boost in economic growth. Similarly, trade-openness has a positive significant long run
impact on the economic growth. Accordingly, a 1-unit permanent increase in trade-openness
stimulates economic growth by 0.38 units. However, the sign of consumer price index and
remittances are a negative and insignificant long run impact on the economic growth at all
significance level. A 1-unit permanent increase in consumer price index and remittances is associated
with almost -0.03 and -1.14 units decline by economic growth in the long respectively. The speed of
adjustment coefficient is found to be negative and significant with 1.32 values indicating that 132
percent of deviation from long run equilibrium due to a disturbance and/or a shock in the system is
eliminated within a year. Granger causality Wald test clearly displays that there is a bidirectional
causality running from financial development to economic growth and from economic growth to
financial development in the long-run. However, there is a unidirectional short run causality running
from financial development to economic growth and it support supply-leading theories in the short
run. Result from impulse response function and variance decomposition was consistent with findings
in the long run and short-run equation. In general, the study suggested that policy makers and
government to focused on long-run policies to promote both financial developments to create a stable
and efficient financial system that can support sustainable economic growth and promoting
sustainable economic growth for promoting sustainable financial development and short-run policies
chiefly enhancing financial development in Ethiopia.
