Abstract

Apart from assessing the impact of  financial development on economic growth, economists have also delved to understand the  direction of causality between the two variables. We examine the causal relationship between the two variables in the Granger causality sense and regress economic growth on financial development and a number of control variables. The Augmented –Dickey Fuller unit root test is used to test for non-stationarity of vairables and the Johansen Vector Autoregressive Cointegration test is utilised to explore the existence of a long-run equilibrium relationship among the variables. We find that all variables are integrated of order one and that they converge to a long-run equilibrium. In the light of these results, we employ an error-correction model. Causality and regression results confirm the contention of Robinson (1952) that the relationship between financial development and economic growth is demand following implying that where enterprise leads, finance follows.  Additonally, results of the growth equation show that the population level, inflation, exchange rate, and openness to trade are significant in explaining economic growth in  Malawi. The study suggests policies consistent with economic growth.

Key words: Non-stationarity, cointegration, financial development, economic growth.

Abbreviation

JEL: EO2, E44, 016