Monash University

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The finance-growth relationship and interaction effects between financial system components: a cross country study

posted on 2017-03-06, 06:01 authored by Nguyen, Yen Ngoc
This thesis examines the finance-growth nexus from a number of aspects. First, it investigates the relationship of the financial system and economic growth, where the financial system is represented by its four main components: banking, stock markets, bond markets and insurance. Second, the thesis examines whether a country’s stage of economic development affects this finance-growth relationship. Third, the inter-relationships between these four financial system components are studied. It utilises a dynamic panel of 90 countries from different economic development levels over the period of 1980-2011. The key regressions are run using the GMM (generalized-method-of-moments) system estimator developed by Arellano and Bond (1991), Arellano and Bover (1995), and Blundell and Bond (1998) to address endogeneity among variables. Regarding the finance-growth relationship, the empirical results suggest that the banking component has a negative relationship with economic growth (possibly with a non-linear relationship). Stock markets hold a positive relationship, but both bond markets and insurance have a mixed relationship with economic growth. When dividing the countries into two groups (developing versus developed countries), the stage of economic development of the country is found to have a significant impact on the finance-growth relationship. This financial components’ impact on economic growth tends to be stronger in developed countries. This is evident throughout all four financial components. The inter-relationships testing between components generate some interesting results. First, banking and stock markets have a two-way substitute relation. Second, banking and bond markets, banking and insurance, and stock markets and insurance all have a two-way complementary relation. Third, stock markets and bond markets hold a substitute relation but only after considering the impact of private bond markets. Fourth, the insurance and bond markets relation is not two-way: bond markets have a negative impact on insurance growth while insurance positively affects bond markets development. This thesis offers several contributions to the financial development - economic growth literature in respect to its approach to measuring the financial sector more completely and then confirming this relationship; its investigation of the impact that a country's stage of economic development have on this relationship; and an examination of the interrelations between the financial sector's four key components. It also makes improvements on the prior work through the use of multiple econometric methodologies, different data settings, and alternative indicators for variables. The findings have several implications for government policy makers. The mixed ‘positive’ finance-growth relationship finding could help policy makers allocate more resources towards developing the ‘right’ sector: e.g. stock markets rather than banking. The lower impacts of finance on growth in developing countries compared to developed countries highlight problems that lower-income countries face in developing their financial systems to generate greater economic growth. An understanding of these substitute and complement relationships can help policy makers put more effort in developing insurance (which supports all three other financial components) and exercise caution with their policies on substitute financial components: banking and stock markets, stock markets and bond markets.


Campus location


Principal supervisor

Michael Skully

Year of Award


Department, School or Centre

Banking and Finance


Doctor of Philosophy

Degree Type



Faculty of Business and Economics

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