Nonlinear Causality Analysis of Finance-Growth Relation: Evidence from Turkey

The aim of this study is to examine the causal relation between financial deepening and economic growth by means of Smooth Transition Autoregressive (STAR) model-based Granger causality analysis applied to the monthly data of Turkey over the period 1998M1-2012M3. The results show that non-linear structure of the series should be considered as the evidence from linear and non-linear causality analysis differs. According to non-linear Granger causality analysis, the financial deepening is found to be causing variable for economic growth in Turkey. (ProQuest: . denotes formulae omitted.)IntroductionThe financial deepening attributed to the development of financial markets has a crucial role in growth process since it provides the efficient allocation of accumulated savings to productive sectors. Though the contribution of finance on economic growth is theoretically postulated, the relation should be examined empirically due to the discrepancies in the regarding literature. According to the framework of Patrick (1966), two possible causal links between financial deepening and economic growth can be classified as demandfollowing view and supply-leading phenomena. The demand-following approach states that the demand of the investors and savers in the real economy for the services of financial sector would lead to the development of financial sector. Furthermore, the supply-leading view, emphasizing the importance of finance for economic growth, points out two functions of the financial sector that are the transfer of resources to modem sectors and stimulation of an entrepreneurial response in these productive sectors. Patrick (1966) seperates the growth process into two stages that begins by supply-leading and proceeds with demand-following approaches. More briefly, in the first stage of growth process, the creation of modem financial institutions contributes to the economic development. However, in the second stage, economic growth induces the demand for financial services and provides financial development. Beside the demand following and supply leading views, the variables in question may be biderectionally related or have no causal link at all.Although the finance-economic growth relation has been widely studied in last decades, the theoretical background of the issue is based on the past literature going back to Schumpeter (1911) that argues the role of financial intermediaries in technological innovation and economic development. More recently, Gurley and Shaw (1955), Goldsmith (1969) and Hicks (1969) point out the importance of financial system for stimulating economic growth. Besides, McKinnon (1973) and Shaw (1973) specify economic growth arising from financial development as a result of financial liberalisation. Contrarily, Robinson (1952) contributes to the related literature from a different perspective arguing that economic growth leads to financial development via increasing demand for financial services.According to Ang (2008) , though the theory can be traced back 1950s, empirical perspective of the finance-economic growth relation has developed since 1990s, following cross-country analysis of King and Levine (1993). As the related study, the evidence of positive effect of financial development on economic growth is supported by Levine and Zervos (1998), Calderon and Liu (2003), Christopoulos and Tsionas (2004), Ang (2009). On the other hand, various studies as Thornton (1996), Darrat (1999), Demetriades and Hussein (1999), Deidda and Fattouh (2002), Dritsakis and Adamopoulos (2004), Shan (2005), Ang and McKibbin (2007), Apergis, Filippidis and Economidou (2007) point to different type of interactions rather than the mechanism that output growth is significantly determined by financial development.Although a wide literature on finance-growth relation has been carried out, this study considerably contributes since the relation is firstly analyzed by employing causality test to a non-linear model, STAR (Smooth Transition Autoregressive Model). …