The Direction of Causality between Financial Development and Economic Growth in Tanzania, An Empirical Analysis

The main objective of this study was to examine causality relationships between financial development and economic growth in Tanzania. In time series context, recently econometric techniques were used; namely Augmented Dickey and Fuller test (ADF) for unit roots, Johansen test for Co-intergration test, Vector Error Correction Model, Granger causality test under VAR framework used to establish direction of causality, and Variance decomposition (VD) applied for validating strengths of findings outside the estimated sampling period. The overall empirical findings can be summarized as follows. Firstly, there is long-run relationship between financial development and economic growth. Secondly, granger causality test suggests economic growth causes financial development in a short-run when broad money to nominal GDP and liquidity liabilities to nominal GDP used, however when credit to private sector to nominal GDP was used findings confirmed evidence of bidirectional causality, and in long run causality run only from financial development to economic growth even in outside the estimated sampling period. Thirdly, financial sector in Tanzania has been effective in promoting economic growth in a short run only. Lastly, capital accumulation channel via gross domestic investments to nominal GDP links financial development and economic growth in a short run, suggesting long-term financial infrastructures necessary for successful promoting investments for spurring economic growth are still remain weak in Tanzania. In view of feedback effect results, study recommend more efforts should be devoted to the deepening of financial sector by enhancing competition, improving business environment, investing on human resources and legal environment