Financial deepening and economic growth in Ghana

Abstract

This study investigated the relationship between economic growth and financial deepening for the case of Ghana using quarterly data from 1983 to 2008. Whereas financial deepening was proxied by credit to private sector/GDP and broad money/GDP, economic growth was measured by real GDP per capita. Other variables included gross fixed capital formation/GDP, interest rate and government spending/GDP. Employing the Johansen cointegration approach, vector error correction, vector autoregressive and Granger causality approaches, the results revealed a positive long run relationship between financial deepening as measured by credit to private sector/GDP and economic growth but no long run relationship when financial deepening was measured by broad money/GDP. The results of the forecast error variance decomposition indicated that the most important variable for economic growth was capital stock. For financial deepening and capital stock, the most influential variable was economic growth. For real interest rate, financial deepening was the most important variable. The study found support for the endogenous growth prediction when credit to private sector/GDP proxied financial deepening. However, evidence for the demandpulling hypothesis was found when financial deepening was proxied by broad money to GDP. The study recommended that the Bank of Ghana could consider enhancing the institutional, legal and regulatory framework to enable financial institutions perform their roles without friction. Government could also consider maintaining and pursuing a consistent development policy as well as ensure a continued implementation of the financial sector reforms.