Supply-leading or demand-following financial sector and economic development nexus: evidence from data-rich Indonesia

Alfan Mansur and Muhammad Nizar

MPRA Paper from University Library of Munich, Germany

Abstract: Supply-leading theory predicts that the financial sector development precedes economic development while demand-following theory believes that the economy should develop, then the financial sector follows. This study exploits the financial sector and economic development relationship in a data-rich environment. Besides the depth, financial access and efficiency are also vital in the financial sector development. We employ a FAVAR model using 22 financial development indicators and 12 economic variables of the monthly Indonesian data series 2015M1-2023M6. Our empirical results reveal the bi-causal relationships between the financial sector and economic development. Then, whether the relationship is more demand-following or supply-leading depends on the measures used and the time trajectory. While an expansion in real GDP seems to have a more persistent impact on the development of financial institutions such as the banking and insurance sectors (demand-following relationship), the supply-leading relationship is influential in the short run. We also find that boosting access to credit and both stock and bond markets provokes economic activities. In addition, the increasing usage of electronic money encourages more consumption of imported goods than domestic goods.

Keywords: financial sector; economic activities; demand; supply; FAVAR (search for similar items in EconPapers)
JEL-codes: C11 C38 C55 E44 G10 G18 G21 G28 (search for similar items in EconPapers)
Date: 2023-11-10, Revised 2023-11-10
New Economics Papers: this item is included in nep-ban, nep-fdg and nep-sea
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:119132

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