Nexus Financial Sector Development And Economic Growth In Ethiopia: Ardl Approach

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.