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Financial Development and Economic Growth Nexus: evidence from Ethiopia (Johnson Approach to Co-Integration)

Abstract: 
The main objective of the paper is to examine empirically the nexus between the banking sector development proxy by the margin between lending and deposit interest rates and economic growth in Ethiopia over the period 1975- 2011.The Johnson approach to Co-integration is employed to investigate the relationships. The test for Co-integration shows that there is a linear long run relationship between real GDP per capita, net interest rate margin proxy for bank efficiency, education (human capital), physical capital stock, and labor force. The estimated long run model reveals that bank efficiency, physical capital stock, and labor growth remained significant variables. The long run estimated model revealed net interest rate margin is positively related to economic growth. This implies that economic growth becomes slow when transaction costs are higher and a small share of savings flows into investment due to the inefficiency of the banking sector. The short run coefficient of error correction term is -0.2461 signifying about 24.61 percent annual adjustment towards long run equilibrium which guarantees the occurrence of a stable long run relationship among the variables. Moreover, the estimated short-run model shows that net interest rate margin is significantly and negatively related to economic growth. This finding is consistent with theory, which advocates that economic growth will get faster when transaction costs get lower and a large share of savings flow into investment. The above results have an important policy implication since most of the earlier studies measured the financial sector development using financial depth (size) which does not necessarily represent the development of financial sector due to its correlation with economic growth. The measurement of bank development by net interest margin exposed that the Ethiopian bank sector development needs further improvements to bring efficiency and competition among commercial banks. Hence, policy makers are required reviewing the legal and institutional arrangements which create financial repression and hinder financial sector efficiency.
 
Publisher: 
Ethiopian Economics Association (EEA)
ISBN/ISSN: 
978-99944-54-44-10
Primary Descriptors: 

Financial Development

Secondary Descriptor: 

Interest Rate

Geographic Descriptors: 
Ethiopia
Cataloge Date: 
09/30/2015
Broad Subject heading: 
Economic Growth
Call Number: 
330.963 PRO 2015
Serial Key Title: 
Proceedings of the Twelfth International Conference on the Ethiopian Economy
Publication catagory: 
Content type: 
Volume: 
I
Publication date: 
2015-06-01 00:00:00
Conference Place: 
EEA Conference Center
Place of publication: 
Addis Ababa, Ethiopia
Type of material: 
Book
Current frequency: 
Annually
Conference date: 
July 16 to 19, 2014