Causality between Financial Structure and Economic Growth in Bangladesh: A Toda-Yamamoto Approach
Economists’ views regarding the relationship between financial structure and economic growth has been evolving since 1950s. The empirical studies that support different views used different methods and were conducted on different countries or country groups. For a fast growing economy like Bangladesh, the examination of the relationship between the structure of financial system and economic growth, which this study aims to, helps policy-makers implement financial economic policies. In contrast to the previous studies which employed either the traditional Granger causality test or the Granger causality test based on the Error Correction Model (ECM), this study applies the ‘Granger no-causality test approach’ developed by Toda & Yamamoto (1995) in multivariate Vector Autoregressive (VAR) setting which is estimated as a seemingly unrelated regression (SUR), using time series data of Bangladesh over the period 1981-2018. The results of the Toda- Yamamoto ‘Granger no-causality test’ identify a unidirectional causality from financial efficiency to economic growth, and bi-directional causality between financial size and economic growth in the case of Bangladesh, but there exists no causality between financial activity and economic growth. It implies that the economy grows faster with a relatively bigger size of the financial market compared to bank size and a relatively efficient financial market compared to banks.
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