Financial developments, structure, and economic growth: evidence from causality tests and time-variation analysis

We restudy the relationship of economic growth with respect to stock market development and banking development for the U.S., the U.K., Germany, Japan, and the BRIC economies. The causality tests support long-run bidirectional causality of both banking and stock market developments with economic growth, and short-run unidirectional causality from stock market development to growth. Our analysis based on a structure time series model further indicates stock market development contributes more for advanced economies while banking development contributes more for developing economies, suggesting financial structure matters to economic growth. The finding also indicates that increasing private credit from banks is associated with lower growth for the U.K., Germany and Japan, and banking development has become less important to growth for the U.S., the U.K., Brazil and India. We show that a measure of industrial productivity can account for this negative link from banking development to growth. The evidence implies too much finance, along with uncertain macroeconomic environment, has stagnated real economic activities that suppresses economic growth.