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American Journal of Applied Sciences 6 (7): 1410-1417, 2009 ISSN 1546-9239 © 2009 Science Publications

Financial Development and Economic Growth An Empirical Analysis for Greece
Athanasios Vazakidis and Antonios Adamopoulos Department of Applied Informatics, University of Macedonia, 156 Egnatias street, P.O. Box 1591 540 06, Thessaloniki, Greece
Abstract: Problem statement: This studyinvestigated the causal relationship between financial development and economic growth for Greece for the period 1978-2007 using a Vector Error Correction Model (VECM). Questions were raised whether financial development causes economic growth or reversely taking into account the positive effect of industrial production index. Financial market development is estimated by the effect of credit marketdevelopment and stock market development on economic growth. The objective of this study was to examine the causal relationships between these variables using Granger causality tests based on a Vector Error Correction Model (VECM). Approach: To achieve this objective unit root tests were carried out for all time series data in their levels and their first differences according to Dickey-Fuller (1979).Johansen co-integration analysis was applied to examine whether the variables are co-integrated of the same order taking into account the maximum eigenvalues and trace statistics tests. A vector error correction model was selected to investigate the long-run relationship between financial development and economic growth. Finally, Granger causality test was applied in order to find the directionof causality between the examined variables of the estimated model. Results: A short-run increase of stock market index per 1% leaded to an increase of economic growth per 0.06% in Greece, also an increase of bank lending per 1% leaded to an increase of economic growth per 0.14% in Greece, while an increase of productivity per 1% leaded to an increase of economic growth per 0.32% in Greece. Theestimated coefficient of error correction term found statistically significant with a negative sign, which confirmed that there was not any problem in the long-run equilibrium between the examined variables. The results of Granger causality tests indicated that economic growth causes stock market development and industrial production index, while industrial production index causes credit marketdevelopment for Greece. Conclusion: Therefore, it can be inferred that economic growth has a positive effect on stock market development and credit market development through industrial production growth in Greece. Key words: Financial development, economic growth, granger causality INTRODUCTION The relationship between economic growth and financial development has been an extensive subject ofempirical research. The question is whether financial development causes economic growth or reversely. The main objective of this study was to investigate the causal relationship between economic growth and financial development taking into account the positive effect of industrial production index. The theoretical relationship between financial development and economic growth goes back to the study of[1]who focuses on the services provided by financial intermediaries and argues that these are essential for innovation and development. Schumpeter[1] view is that a well functioning financial system would induce technological innovation by identifying, selecting and funding those entrepreneurs who would be expected to successfully implement their products and productive processes. Robinson[2] claimsthat “where enterprise leads, finance follows”-it is the economic development which creates the demand for financial services and not vice versa. Financial development follows economic growth as a result of increased demand for financial services. This explanation was originally advanced by[3]. Theory provides conflicting aspects for the impact of financial development on economic growth. The...
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