Impact of Financial Development on Economic Growth

In this thesis I analyze the relationship between financial development and economic growth in Latin America. The main objective is to find evidence of the supply-leading phenomenon in the region. The financial sector is expected to influence economic growth through its main functions that facilitate business transactions that have a positive impact on economic growth. The analysis is conducted with growth equations including two different financial development indicators estimated by the fixed effects model and its extension including instrumental variables. The issue of endogeneity is corrected for, which then allows for the proper analysis of the impact and causal relationship between economic growth and financial development in the Latin American countries. Data from the developing countries in Latin America and developed countries of the OECD are used in the estimations allowing for comparisons between the two. The findings of this study suggest that there is no considerable support for the supply-leading phenomenon in the region which indicates a case for the demand-following phenomenon in Latin America. This slightly differs from the findings for the developed countries where more support is found for the supply-leading phenomenon. Moreover, the two different financial development indicators point towards the opposite conclusion regarding the relationship between financial development and economic growth.