Does Financial Deepening Cause Economic Growth? Evidence from the Economic Community of West African States (ECOWAS)

Abstract

Deeper financial systems have long been associated with economic growth in economics literature. The financial sector is seen as the central nervous system of any economy, hence its importance in the economic development of any nation. The financial system ensures that savings are mopped up in the economy and allocated to users of funds to increase production of goods and services. The paper examined whether financial deepening leads to economic growth in the Economic Community of West African States (ECOWAS) using panel data covering the period 2000 to 2016. The results of panel unit root tests reveal that all the variables are integrated at I(1) while the Kao and Pedroni co-integration tests indicate that there exist a long-run relationship among the variables. The regression results of the random effects and the System Generalised Methods of Moments (GMM) models suggest significant and positive relationships between economic growth and financial deepening, ratio of foreign direct investment to Gross Domestic Product (GDP), and ratio of investment to Gross Domestic Product (GDP). The paper suggests that the central banks and governments of the member countries of ECOWAS should consistently formulate and implement policies that would promote financial development. Policy direction should emphasize financial inclusion and the flow of credits at affordable rates to the productive sector of the economy in order to increase and sustain the impact of the financial sector on the economic development of the ECOWAS.