Financial deepening and economic growth nexus in emerging economies in Africa: does supply-leading or demand-following hold?

Abstract

This research examines the long-term causation between financial deepening and economic growth in African-emerging economies. The fully modified and dynamic ordinary least square methods are used. Bidirectional causality exists between domestic credit to the private sector, money supply ratio, trade openness and gross domestic product per capita. Unidirectional causality flows from capital formation to gross domestic product per capita. The central banks should apply policies which encourage credit flow to private enterprises via banks’ intermediation and eliminate the bottlenecks undermining credit flow. The governments should establish an investment friendly environment in all sectors and upgrade the productive capacity. Studies have been conducted on the nexus of financial deepening and economic growth with debatable outcomes. Some studies illustrate a positive alliance between financial deepening and economic growth, supporting the supply-leading model. Other findings support the demand-following theory, while some demonstrate mutuality in the nexus between financial deepening and economic growth. Nevertheless, limited studies have been conducted on the nexus between financial deepening and economic growth to ascertain if the supply-leading or demand-following hypotheses hold.