Abstract
This article investigates the Granger causal relationship between financial development and economic growth for four small open economies over the period 1960 to 2003. Both long- and short-run Granger causality tests are used to assess the finance-growth nexus. The results suggest that there is a positive association between financial development and growth in all countries. However, the long-run causality tests show that growth tends to lead financial development in Singapore and Jamaica, financial development leads growth in Trinidad and Tobago and there is a bidirectional link in Barbados. These results therefore suggest that cross-country studies could overstate the impact of financial development on growth, since they ignore differences – even in relatively homogenous groups.
Notes
1 If X is an n × k data matrix, the first principal component is a vector z = a 11 x 1 + ··· + a 1k x k that minimizes the sum of squared distances from the various vectors in X (see Jolliffe, Citation2002, for more details).
2 Structural changes, especially changes to monetary regimes, could impact on the coefficient estimates obtained. However, the cointegration graph suggested that the relationship was relatively stable over the sample period.