The effects of income and inflation on financial development

 

    The effects of income and inflation on financial.         development: evidence from heterogeneous panels



In this article, we investigate four issues that remain inconclusive in the literature relating to the effects of real GDP and inflation on financial development. First, in the finance-growth nexus, the demand-following hypothesis posits that financial development responds to growth in real GDP per capita (hereafter referred to as GDP), since an increase in GDP engenders households and firms to increase their demands for financial products, services, intermediaries and institutions. To meet these increased demands, the financial sector embarks on innovations and technology which facilitate the development of the sector. The empirical literature on demand-following hypothesis found evidence suggesting that growth in GDP precedes financial development (Gozgor, 2015; Peia and Roszbach, 2015; Zang and Kim 2007). Yet, while Baltagi et al. (2009) and Law and Habibullah (2009) found that GDP is a significant determinant of financial development, Cherif and Dreger (2016) reported otherwise in emerging market economies. The differences in the empirical findings may be due to the inability of the studies to account for differences in the level of GDP across the countries. Thus, whether or not the impact of GDP or income2 on financial development is uniform across countries with diverse income levels remains unresolved.



                                                                    Urooj Qureshi