FINANCIAL DEEPENING AND ECONOMIC GROWTH: TIME SERIES EVIDENCE FOR MALAWI

Abstract

The overriding objective of this study is to investigate the causal relationship between financial deepening, taken to mean an increase of financial assets in the economy, and economic growth in Malawi. The empirical investigation is based on the neoclassical growth model augmented with financial deepening and other growth-related factors, using annual time-series data covering the period 1970-2004. Cointegration analysis and Error Correction Mechanism (ECM) were used to investigate this relationship. Results of the study indicate that there is a robust positive long-run relationship between financial deepening and economic growth. Furthermore, human capital, trade openness and investment were also found to share a positive relationship with economic growth. Inflation was found to exert a negative influence on economic growth. Financial liberalization was also found to impact positively on economic growth. The empirical results of this study yield some policy implications. The results suggest the need for concerted efforts to improve the growth of financial saving as well as the need to improve the level of financial intermediation so that a larger set of clients can access credit from financial intermediaries. The important role of investment in determining economic growth underscores the need for policies that will attract both foreign and domestic investment. Furthermore, the results indicate that there is need for policies that improve the education sector as well as those that curb inflation and maintain it at minimum levels.