Abstract:
This paper investigates linkage between financial development and economic growth in Ethiopia
during the period from 1975 to 2016 using Autoregressive Distributed Lag (ARDL) approach.
The paper also schedules Vector Error Correction Model (VECM) in order to observe how fast
the co-integrated variables convergence in long-run. Accordingly, the results of bound test
confirm existence of the long-run relationship between explanatory variables and economic
growth. The empirical results show evidence of long-run and short-run positive impacts of
financial development on economic growth in Ethiopia which implies that progresses in financial
sector contribute to economic growth in both short-run and long-run. In consideration of few
control variables, the study finds all indicators, except inflation and government expenditure,
significantly influence economic growth in the long-run. However, it also reveals that
government expenditure, trade openness, private credit sector, and bank liquidity ratio are
pioneering determinants the economic growth in Ethiopia in short-run. Moreover, the study
employs Granger causality tests in order to show direction of impact is running from financial
development to economic growth both in short-run and long-run. As a result, it finds that the
supply-leading hypothesis holds in Ethiopia and the policy implication is that long-run policies
of financial development are believed to provide significant effect on economic growth.
