A Reassessment of Finance-Growth Nexus for Pakistan: Under the Investigation of FMOLS and DOLS Techniques

Muhammad Shahbaz

The IUP Journal of Applied Economics, 2009, vol. VIII, issue 1, 65-80

Abstract: The present paper empirically investigates the validity of the question whether financial sector s development contributes to economic growth in a small developing economy like Pakistan. The paper employs a relevant measure of financial development that meets the requirements of the finance-growth theory. The dynamic relationship between per capita GDP and financial development is investigated by employing two advanced techniques, FMOLS and DOLS to test the robustness of the long-run relationship after testing the order of integration of the variables. Empirical findings suggest existence of stable relationship between per capita GDP and financial development. Regression results of FMOLS reveal that financial sector s development improves the performance of the economy in the long run, but declines economic growth in the short run. Credit to private sector as a share of GDP, used as a proxy for financial development, is a good predictor of economic growth in the long run, in case of Pakistan. The results reveal that rise in exports also boosts economic growth in the long run, and investment stimulates economic growth both in the long run as well as short run, through its direct and indirect channels. Inflation and imports both reduce economic growth. And finally, high economic growth is found to be associated with small size of the government.

Date: 2009
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