The study examines the nexus between financial development and economic growth in Ghana over the period 1970-2013. The stationarity test result shows that the order of integration of variables included in the model was a mixture of I(0) and I(1). Therefore the study employs the bounds testing approach to cointegration and error correction models developed within the Autoregressive Distributed Lag (ARDL) framework to explore the long-and short-run effects of financial development on economic growth. The study uses five different measure of financial development including, credit to the private sector, narrow money, broad money, ratio of narrow money to broad money and domestic credit. The study also investigates whether there are other determinants of economic growth. Evidence of both long-run relationship and short-run dynamics was found amongst the various financial development indicators and economic growth. Precisely, the results showed that credit to the private sector, ratio of narrow money to broad money, narrow money, broad money and domestic credit influenced economic growth in the long-and short-run. Again, inflation and government consumption expenditure were found to impede economic growth in the long-run and short-run. Contrarily, capital stock, trade openness and FDI were found to stimulate economic growth both the long-and the short-run. When credit to the private sector was used as an indicator for financial development, financial sector liberalisation was positive. The study recommends that policy makers should take caution in the choice of financial development indicator as a policy instrument for the attainment of growth and development. Again on the basis of empirical evidence, policies to improve the accessibility of affordable credit by the private sector, including small and medium scale enterprises should be enforced.

1.1 Background of the study
Globally, a delicate concern of every economy is the attainment of greater heights in the level of growth and development through positive changes in production levels of goods and services. The attainment of sustainable levels of economic growth is a core macroeconomic objective of an economy. Empirically, some traditional factors and the distinct interactions amongst each other have been identified to play a crucial role or increasing levels of growth (see Solow, 1956). Among these can be mentioned, capital, labour and land. Notwithstanding this, the new theories of growth have also identified technological changes as a key driver to the engine of growth as it stimulates productivity.

Over the years the relevance of an efficient and adequate financial system has also been recognized to play a role for increased levels of growth (see Sala-i-Martin, 1992; King and Levine, 1993, Easterly, 1993, Khan and Senhadji, 2000 and Khan et al 2005). This is buttressed by the fact that a sound financial system not only contributes to economic transformation but also creates an enabling environment conducive for the mobilization and allocation of funds geared towards increasing patterns of growth and development (Levine, 1997). Schumpeter (1911), McKinnon (1973) and Shaw (1973) also note that an economy with an adequate and efficient financial system tends to experience increased growth patterns as it encourages various technological innovations. It is for this reason amongst many others that most developing countries opted for reform programs in their financial sectors during the eras of economic imbalances in various sectors of the economy including the financial sector.

Development in the financial sector is the instance that makes an improvement in the quality, and efficiency of financial intermediary services. More specifically, development in the financial sector implies adequately utilizing, financial resources in mobilizing and allocating resources to prioritize development in the real sectors of an economy (Aryeetey et al., 2000). For most developing countries the introduction of various economic reforms including financial reforms was basically aimed at reaping the benefit of high rate of economic growth obtained from a well-developed, effective and efficient financial system. Ghana is no exception to these groups of countries that have implemented some economic reforms when faced with major set-backs in its financial sector.

Prior to the implementation of the sector-wide reforms of the financial system, Ghana financial sector was faced with financial repression and/or shallowing and hence causing its failure as an intermediary to the attainment of growth levels in real sectors (manufacturing and agriculture) of the economy (Adu et al., 2013). Ghana introduced the Financial Sector Adjustment Program (FINSAP) in 1988 to help liberalize the financial sector which was challenged in the early 1980s. This exerted a significant and positive effect on various financial systems hence the growth of the economy over the years of implementation. For instance, during the period, there was a significant increase in the banking sector as the number of banks in the economy increased relatively compared to the pre-liberalisation periods. Specifically, the number of banks in country rose from ten with 405 branches in 1988 to twenty seven with 696 branches by 2009 (Adu, et al., 2013). In addition, the banking sector of the economy became more vibrant with the increase in total bank assets from approximately 0.31% of GDP in 1993 to approximately 0.66% by 2008. Following the implementation of the FINSAP, there were appreciable upswings in various financial indicators including, capital adequacy, savings/deposit mobilization, interest rate liberalisation, sectoral credit allocation, asset allocation and concentration amongst many others.

1.2 Problem Statement
Controversies surrounding the role of the financial system to the engine of economic growth have caused the finance-growth link hence cannot be overlooked. Despite the fact that there have been various perspectives on the relationship between financial development and economic growth in terms of causation, literature shows that various economists hold different perspectives. Patrick (1966) states two major hypotheses that explain the causal link and its direction exiting between finance and economic growth. These include, the supply-leading hypothesis and the demand following hypothesis.

The former perceives a unidirectional relationship running from financial development to economic growth with no feedback effect. In other words, economists supporting this argue that the establishment of efficient and adequate financial systems, markets and institutions will cause relative increase in the supply of financial services thereby leading to increasing patterns of economic growth. Various empirical studies, including Mckinnon (1973), Levine et. al., (2000), King and Levine (1993a, b), Levine, (2004), Neusser and Kugler (1998) and Ogwumike and Salisu (2009) support the supply-leading hypothesis. Contrarily, the demand-following hypothesis posits that the causal link is from economic growth to financial development. Intuitively, followers of this hypothesis also argue, as an economy grows, there is a relatively high demand for financial services hence causing improvement in the financial sector. Meaning, financial sector development is positively related to increasing growth patterns. Empirically, there have various studies supporting the demand-following hypothesis (see Gurley and Shaw, 1967; Goldsmith 1969; Jung, 1986).

Although there have been various cross-sectional and panel studies in various countries (King and Levine, 1993, Fernadez and Galetovic, 1994 and Saci, et al. 2009). However there is an assertion that cross-country studies are unable to reflect country specific results mainly due to the act that, different countries pose different economic, social, political and institutional characteristics (Arestis and Demetriades, 1997; Rousseau and Wachtel, 2001 and Rioja and Valev, 2004). In this vain, it can be noted that it will appropriate and relevant to conduct a country specific analysis rather than a panel analysis on the finance-growth nexus.

Furthermore, literature search has shown that only few studies have been conducted in Ghana. (see Quartey and Prah, 2008; Esso, 2010 and Adusei, 2013). Quartey and Prah (2008) uses four financial development indicators (broad money as a ratio of GDP, domestic credit as a ratio of GDP, private credit as a ratio of GDP and private credit to domestic credit ratio) to investigate the bivariate causal linkage among financial development and economic growth. Esso (2010) also conducts a study on the relationship between growth and financial sector development on a panel of ECOWAS countries including Ghana. The researcher used credit to the private sector as a sole measure of financial development. Adusei (2013) According to literature it is reasonable to argue that there is no single indicator that could be considered as an adequate measure or proxy for financial development in country. Hence for every economy, there should be a relative large set of proxies for the level of financial development. This study will not only fill the lacuna of increasing the time period but will also consider five different proxies of financial development including credit to the private sector, ratio of narrow money to broad money, narrow money, broad money and domestic credit.

It can hence be noted from the aforementioned discussions, that an in depth analysis of the nexus of financial development and economic growth in Ghana is required.

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Item Type: Ghanaian Topic  |  Size: 62 pages  |  Chapters: 1-5
Format: MS Word  |  Delivery: Within 30Mins.


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