THE GROWTH OF FINANCIAL DEPTH AND ECONOMIC GROWTH NEXUS IN ETHIOPIA

Abstract

The study examines the relation between economic growth and financial depth exists in Ethiopia. It employs vector error correction (VECM) approach to assess how the financial sector affects growth. In addition the study applied the granger causality test so as to find the direction of causality between financial depth and economic growth. Impulse response is also functional so as to see the relations between financial depth and economic growth. The study utilized time-series data of Ethiopia over the period 1970-2016. The findings support the existence of a bi-directional causality from economic growth to financial depth and financial depth to economic growth for private credit and uni directional causality running from economic growth to broad money (M2). Result, shows the presence of positive and significant long-run relationship between financial depth indicators broad money (M2) and Private credit (PRIV). However, Broad money has an insignificant effect in the short-run and credit to private sectors (PRIV) had significant and positive impact in the short run. The results of Impulse response also indicate the permanent effect of financial depth on economic growth. Therefore adequate policies and efficient supervision of all financial institution should be provide and sustained in order to stimulate economic growth. And the national bank of Ethiopia (NBE) should regulate private sector credit by reducing interest rate for productive sector of the economy mainly on investment on capital goods. Policy makers also should focus on long run macroeconomic stability.