Does financial development drive economic growth ? an ARDL approach

This paper examines the Granger-causal relationship between financial development and economic growth. India is taken as a case study. The Auto-Regressive Distributed Lag (ARDL) method (also known as the bounds testing approach) proposed by Pesaran-Shin-Smith (2001) has been employed The study finds that financial development and economic growth are cointegrated in the long run i.e. there is a long run theoretical relationship between these variables. Our findings are in line with (McKinnon (1973); King and Levine (1993a, b); Neusser and Kugler (1998); Levine (1997); Beck (2000). For a developing country like India financial development is evidenced to lead growth rather than the other way around. This has a major policy implication for the government of India. If government wants to increase economic growth, it can do so by bringing out reforms in the banking sector and capital market sector. Hence, India may consider banking sector and capital market sector as the policy variables and the authorities should take necessary steps to bring about reforms in these sectors to enhance economic growth in the economy