Financial development and economic growth: the effect of public debt

Abstract

The objective of this article is to analyse the relationship between financial development and economic growth, taking into account the level of public debt in 88 countries from 1996 and 2020. Two measures of financial development has been used : the ratio of credit granted to the private sector to GDP and the liquid assets of the financial system relative to GDP. To perform the estimates, the generalized method of moments was selcted. Two main result were obtained. First, there is no positive contribution between financial development and economic growth. Second, financial development does not stimulate economic growth in countries where the level of public debt is high. Spécifically, when public debt reach 65% or 72% of GDP, financial development does not positively impacts economy growth. However, financial development is beneficial for growth in countries where public debt is low or modarate, it is to say when it less than 65% or 72% of GDP. For financial development to positively impact economic growth, it is important for heavily indebted countries to bring their debt down to an optimal level. But it is equally crucial that borrowing by low-debt countries is used to finance productive investments.

Keywords : Financial development, economic growth, public debt, , GMM

JEL Classification : E44 ; G20 ; O4

Paper type : Empirical research