Table of Contents

1 Introduction 1

2 Literature review 1

1.2. Theoretical review of financial development and economic growth nexus 1

1.3 Review of the empirical literature 4

1.3.1 Time series 5

1.3.2 Cross-country studies 6

1.3.3 Panel data studies 7

3 Conclusions 8

4 References 9

1 Introduction

“Finance is powerful. The financial system can be an engine of economic prosperity – or a destructive cause of economic decline and misery.” Levine, R. (2011) p.85

Obviously, financial system and economy are related. But what is the nature of this relationship? The objective of this paper is to critically evaluate the existing theoretical and empirical literature on the finance-growth nexus.

What is the role of the financial sector in economic growth? Does finance cause growth or simply follows it? There is no wide agreement about this task among recognised economists. Even Nobel Prize winners disagree in regard to the role of finance in economic development.

Levine (2003) states that the role of finance as a major determinant of economic growth is over-stressed. Moreover Levine (2003) argued that where enterprise leads finance follows. Quite the opposite, important acknowledgment should be taken into account and it follows as “[the idea] that financial markets contribute to economic growth is a proposition too obvious for serious discussion.” Levine (2003) p.1 Similar to that, he also declared that the finance growth nexus cannot be safely ignored without substantially impeding our understanding of economic growth.

Our understanding about the role of financial factors in economic growth has consequences on further researches of financial systems. Even more important, “a better understanding of the finance-growth nexus may influence public policy choices since legal, regulatory, tax, and macroeconomic