The role of inflation in financial development–economic growth link in sub-Saharan Africa

Abstract

The impact of financial development (FD) on economic growth (EG) is well documented. However, studies on how inflation mediates the impact of FD on EG produce inconclusive findings. Meanwhile, the tripartite relationship among FD, inflation and EG is particularly crucial for sub-Saharan African countries given that these countries are largely inflationary on the back of under-developed financial sectors and low EG. The inconclusive evidence presented by the existing studies limits policy making. This study therefore re-examines whether inflation mediates the FD–EG nexus by utilizing a panel data obtained from 36 countries in sub-Saharan Africa. The study uses the sample splitting threshold approach to investigate this relationship. The findings identify inflation thresholds of 7.65% and 6.76% at which the impact of FD on EG changes sign. Specifically, irrespective of the indicator of FD, higher FD significantly increases EG at low inflation rates. However, beyond the estimated thresholds, the impact of FD on EG is insignificant, revealing that higher inflation does not support the growth-enhancing effect of FD. The research recommends that inflation should be kept below the identified thresholds for FD to spur EG.

Keywords:

• EG
• inflation
• threshold
• financial development

JEL Classification:

• O47
• E44
• E31

PUBLIC INTEREST STATEMENT

Improving financial sector development is one of the major policy objectives of African countries. This is based on the evidence that higher financial sector development increases economic growth and therefore supports in achieving the Sustainable Development Goals (SDGs) and Agenda 2063. This notwithstanding, there are concerns that unbridled financial sector development could dampen economic growth given the level of countries’ macroeconomic instability. This study therefore examines the precise effects of financial development on economic growth in Africa given countries’ inflation rates. The findings presented are important to guide policymaking.

Acknowledgements

The financial support of the University of Economics Ho Chi Minh City is fully acknowledged. We are also very grateful to the anonymous reviewers and the Editor, Dr. Raoul Fani Djomo Choumbou for the constructive comments on the earlier drafts of this paper. The usual disclaimer applies.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. The selection of these countries is contingent on data availability and they include Angola, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Central African Republic, Congo Republic, Cote d’Ivoire, Democratic Republic of Congo, Ethiopia, Gabon, Gambia, Ghana, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mauritius, Mozambique, Namibia, Niger, Nigeria, Rwanda, Senegal, Sierra Leone, South Africa, Sudan, Swaziland, Tanzania, Togo, Uganda and Zambia.

2. Private credit is by far the most widely used single measure of finance in recent empirical literature (see, Adeusi & Aluko, 2015; Aluko & Ajayi, 2018; Sare et al., 2019; Ajayi & Aluko, 2019; Opoku et al., 2019b; Ibrahim et al., 2019; Ibrahim & Sare, 2018; Ibrahim, 2018; Ibrahim & Alagidede, 2017).

3. The data is only available up to year 2014, hence it is averaged over the period 1996–2014.

4. The average value of the financial development index for 25 countries included in the sample is below 0.14.

Additional information

Funding

This study was funded by the University of Economics Ho Chi Minh City, Vietnam.

Notes on contributors

Muazu Ibrahim

Muazu Ibrahim holds PhD in Economics and Finance from University of The Witwatersrand, Johannesburg, South Africa. He is the Research Officer of Making Finance Work for Africa (MFW4A), African Development Bank (AfDB), Abidjan, Cote d’Ivoire. He previously worked for the Macroeconomic and Governance Division (MGD), United Nations Economic Commission for Africa (UNECA), Addis Ababa, Ethiopia. He is a Research Fellow with the University of Economics Ho Chi Minh City, Vietnam. His research focuses on development and international finance.

Olufemi Adewale Aluko

Olufemi Adewale Aluko holds a Master of Science degree in Finance from University of Ilorin, Kwara State, Nigeria. He is presently studying for a PhD in International Business at the Leeds University Business School, University of Leeds, UK. His research interests include but not limited to development finance, international finance and financial economics. His research has been published in peer-reviewed journals such as Energy Economics, International Economics, International Journal of Economics and Finance, Structural Change and Economic Dynamics, Journal of Environmental Management, among others.

Xuan Vinh Vo

Xuan Vinh Vo is a Professor of Finance at the Institute of Business Research, University of Economics Ho Chi Minh City, Vietnam and CFVG Ho Chi Minh City, University of Economics Ho Chi Minh City, Vietnam. His research focuses on the areas of macroeconomics, banking and finance. He has published extensively in top-tier peer-reviewed journals.