Financial Devalopment and Economic Growth: Evidence from Liberia

Abstract

The relationship between financial development and economic growth is a contentious issue. For developing countries, empirical studies have provided conflicting results. This study seeks to empirically explore the relationship between financial development and economic growth in Liberia over the period 1960-2016. Consequently, the study employs the bounds testing approach to co-integration and error correction models developed within the Autoregressive Distributed Lag (ARDL) framework to explore the long-run and short-run effects of financial development on economic growth in Liberia. The empirical results indicate the existence of a long run relationship between economic growth and financial development in Liberia. The result of the error correcting term (ECM) indicates an adjustment to the equilibrium state after a shock. The lagged error term coefficient has the correct sign and is significant at 1% test level. This suggests that about 92% of distortions created by shocks in the preceding year can be restored in the current year. This serves to further affirm the presence of long-run financial development and economic growth nexus in Liberia. In the short run, however, the results showed that financial development and economic growth are insignificantly related. Consistent with the findings, it is recommended that processes and institutions that facilitate a sound and competitive financial market must be improved for efficient allocation of credit and insurance, collection of loans, and secure and efficient payment services based on transaction accounts, as well as the protection of depositors and safety of the financial system. These reforms would contribute to improving the quality and affordability of financial services available to consumers and business of all sizes, particularly SMEs and to low-income households and thus spur growth.