This study investigates the dynamic relationship between financial deepening and economic growth in
Jordan over the period (1992-2014). Vector auto regressive regressions, Granger causality and
Johansen-Juselius conitegration tests are employed to achieve the objectives of the study. Using quarterly
data, the results indicate no statistically significant effect of financial deepening on economic growth on
the short run. However, the cointegration tests show a statistically significant long run equilibrium
relationship between the two variables regardless of the proxy used for financial deepening. Moreover,
the Granger causality test show a bi-directional causality between economic growth and financial
deepening when the latter is measured by the amount of credit granted to private sector. However, a one
way causal relationship from the economic growth to financial deepening is found when the amount of
deposits and money supply (M2) are used as proxies of financial deepening. These findings have
important implications to academicians and policy makers in Jordan.
Introduction
Financial deepening is defined as the increased provision of financial services with a wider choice of
services geared to all levels of society. It generally means an increased ratio of money supply to GDP, in
other words, it refers to liquid money. The more liquid money is accessible in an economy, the more
chances exist for continual growth (Shaw, 1973). Financial deepening stimulates higher investments,
faster growth and more rapidly rising living standards.
Jordan is a developing non-oil-producing country with limited natural resources and water. The
Jordanian economy is one of the smallest in the Middle East with a GDP of JD 23, 851.6 million and a
population of 6,530,000 (central bank of Jordan, 2013). The commodity producing sector represents
33.4% of the GDP while the greatest percentage is to the service producing sectors which represent 66.6%
of the GDP according to the statistics of year 2013 (central bank of Jordan, 2015). Jordan is rapidly
growing, both as a result of its population demographic and due to an influx of refugees over the past
decades. On the other hand, Jordan has a financially sound distinguished banking system. The Jordanian
financial stability report (2013) revealed that the size of the banking system comprises approximately
94.0 % of the size of the financial sector, and hence, banks are considered the main component of the
financial sector in Jordan. The banking sector in Jordan is considered as one of the main pillars of the
Jordanian economy. It is well capitalized, highly regulated and maintaining high levels of profitability,
158 Journal of Accounting and Finance Vol. 16(6) 2016
expansion and growth over years although of the overabundance of events that have been taking place
since the beginning of the year 2011 following what is called ‘the Arab spring’.
The linkage between financial deepening and economic growth is well documented in both the
theoretical and the empirical literature. A better understanding of this relationship has important
implications to academicians, practitioners and policy makers. Hence, the financial system mobilizes
pools and channels funds into productive capital and by doing so it contributes to economic growth. On
the other hand, if the linkage goes from economic growth to financial development, then under this logic,
the economic growth would increase demand for sophisticated financial instruments, which in turn leads
to development in the financial sector (Levine, 2005). This study investigates the dynamic relationship
between financial deepening and economic growth in Jordan over the period (1992-2014). The remaining
of the study is organized as follows: Section 2 reviews the literature, Section 3 describes data and
Methodology, Section 4 reports the results of analysis and Section 5 concludes.
Literature review
A huge amount of literature has examined the relationship between financial development and
economic growth. The early evidence starts by the most influential works in this topic (Goldsmith, 1969;
Mckinnon, 1973; Shaw, 1973). Goldsmith (1969) investigates the effect of financial structure on
development in 35 countries over the period (1860-1963). He documents a positive relationship.
Consistently, Mckinnon (1973) inspects the same issue in Argentina, Brazil, Chile, Germany, Indonesia,
Korea and Taiwan in the post World War II period. He finds that better functioning financial systems
stimulate faster growth. Shaw (1973) introduces supporting evidence. He shows that financial
intermediaries promote investment and raise output growth through borrowing and lending.
The succeeding papers use different models, techniques and control variables on both the aggregate
and individual country levels and find a positive impact of financial development on economic growth
(Bencivenga and Smith, 1991; King and Levine, 1993b; Pagano, 1993; Benhabib and Spiegel, 2000;
Levine et al., 2000; Rioja and Valev, 2004). King and Levine (1993a) study the relationship between
financial development and output growth for 80 countries over the period (1960-1989). They document a
contemporaneous relationship. Moreover, they conclude that the predetermined component of financial
development is a good predictor of long-run growth over the next 10 to 30 years. Darrat (1999)
investigates the role of financial deepening in economic growth in three middle-eastern countries (Saudi
Arabia, Turkey and the United Arab Emirates). He focuses on the causal relationship between the two
variables. His findings generally support the view that financial deepening is a necessary causal factor of
economic growth. However, the strength of the evidence varies across countries and across the proxies
used to measure financial deepening. Darrat (1999) argues that the causal relationships are also
predominately long-term in nature. Calderon and Liu (2002) employ the Geweke decomposition test
(Geweke, 1982) on pooled data of 109 developing and industrial countries to examine the direction of
causality between financial development and economic growth over the period (1960-1994). They find a
bi-directional causality between the two variables. Moreover, they argue that financial deepening
contributes more to the causal relationships in the developing countries than in the industrial countries.
Alzubi et al (2007) investigate the relationship between financial development and economic growth in
MENA countries over the period (1989-2001). Using panel data analysis, their results show that all
financial indicators are insignificant and do not affect economic growth in these countries. Alternatively,
the public sector is found to dominate economic activities. The authors argue that the financial sectors are
still underdevelopment and need more efforts to be able to exert their functions effectively in the Arab
MENA countries. Apergis et al. (2007) inspect whether a long-run relationship between financial
development and economic growth exists employing panel integration and cointegration techniques for a
dynamic heterogeneous panel of 15 OECD and 50 non-OECD countries over the period 1975’2000.
Their findings support the existence of a single long-run equilibrium relationship between financial
deepening, economic growth and a set of control variables.
Journal of Accounting and Finance Vol. 16(6) 2016 159
In Jordan, Abu-Mhareb and Al-Fyoumi (2011) examine the causal relationship between stock market,
banks and economic growth in order to find whether financial development is supply-leading or demandfollowing
over the period (1992-2010). The results of the study do not support the hypothesis that
financial development lead to changes in economic growth in Jordan. However, they provide evidence
that the effect of the local macroeconomic variables (trade openness and industrial production) on the
economic growth is more important than that of financial indicators. In addition, Granger causality test
confirms the presence of a significant unidirectional causal relationship running from economic growth to
bank credit granted to private sector in Jordan. Aljarrah et al. (2012) examine the impact of financial
development on economic growth in Jordan over the period (1992-2011). They find that financial
development as measured by the ratio of banking sector assets as percent of GDP, ratio of currency
outside banks as percent of narrow money supply and ratio of private sector credit as percent of total
banking sector credit is significantly correlated with economic growth. However, their results indicate a
causal relationship only from the ratio of banking sector assets as percent of GDP to the economic
growth. Masoud and Hardaker (2013) investigate the role of the financial market in economic growth
over the period (1980-2012). Based on causality and cointegration tests, their results indicate a bidirectional
relationship between the two variables on both the short and long run. However, they argue
that the financial market in Jordan is not a leading part of the economic development process.
Consistently, Elian and Sulaiman (2014) find a limited bi-directional causality relationship between
equity market and economic growth over the period (1980-2009). Abu Alfoul et al. (2014) examine the
causal relationship between financial development and economic growth for the period 1965 to 2004.
Using Toda and Yamamoto (1995) Granger-no-causality model, their results reveal that there is a unidirectional
Granger causality from economic growth to financial development when the latter is measured
by the ratio of the credit granted to private sector to GDP.
DATA AND METHODOLOGY
Our data set consists of the quarterly observations of the GDP per capita, total credit granted to
private sector, total deposits, money supply (M2), lending interest rate, consumer price index, total
amount of exports and imports and government expenditures over the period (1992-2014). The variables
of the study are defined as follows:
Economic Growth: economic growth (GDP) is measured by the growth rate in per capita GDP.
Financial deepening: Financial deepening is measured by three proxies, the total credit granted by banks
to private sector divided by the GDP (Credit), the total deposits to GDP (Dep) and the money supply
(M2) to GDP (MS).
Control variables: the control variables include inflation (INF) calculated as the percentage change in the
consumer price index, interest rate (INT) measured as the lending rate, the degree of openness (Open)
measured as the total imports and exports divided by the GDP and the government expenditures as a
percentage of GDP (EXP).
In order to examine the short run dynamic effect of financial deepening on economic growth, we
employ a vector autoregressive regression. The following VAR is estimated three times each using a
certain proxy of financial deepening:
t t ptp t ptp t tptp GDP += GDP ++ GDP FD +++ FD + Cont ++ + eCont ” ‘ ” ‘ ” ‘ ‘ ” ‘ ” ‘ .. .. .. 1 1 11 1 1
160 Journal of Accounting and Finance Vol. 16(6) 2016
Where GDP denotes economic growth. FD denotes financial deepening. Cont denotes the control
variables which include the lagged values of INF, INT, Open and EXP. Akaike Information Criteria is
employed to determine the number of lags in VAR.
Thereafter, Granger causality tests are performed as follows:
tjt
m
j
it j
n
i
t i GDP B FD GDP e1
1 1
1 += + ‘ + =
‘
=
tjt
n
j
it j
n
i
t i FD GDP FD e2
1 1
2 += + ‘ + =
‘
=
The long run equilibrium relationship between economic growth and financial deepening is examined
by the Johansen-Juselius conitegration test. Johansen (1988) and Johansen and Juselius (1990) suggested
two likelihood ratio tests to determine the number of cointegration vectors. These tests are trace and
maximum eigen value, which are estimated as follows:
Trace Test= )( )1ln(
1
‘+=
”=
ri
”Trace Tr ”i
Maximum Eigen Value Test = )1ln()1,( ” Max Trr ”=+ ”r+1
Where ‘T is the number of observations. ”i is the th i largest eigen value. r is the number of
cointegrations. The null hypothesis of trace test is that there are at most r cointegration vectors. In other
words, the number of cointegration vectors is less than or equal to r. The null hypothesis for maximum
eigen value test is that there are r cointegration vectors.
RESULTS OF ANALYSIS
Table 1 reports the results of the Augmented Dickey-Fuller test of the study variables. All the test
statistics are significant so the null hypothesis of a unit root is rejected for all the variables investigated.
Thus, the time series are stationary. The reason is that the first percentage differences are used for
calculating the growth rate in the variables of the study. Table 2 shows the estimation results of the three
VAR models. The results indicate no statistically significant short term effect of financial deepening on
economic growth regardless of whether the financial deepening is measured by the total credit granted to
private sector or total bank deposits or the money supply (M2). These results are consistent with the
findings of (Alzubi et al, 2007) who find that the financial sectors are still underdevelopment and do not
strongly promote economic growth in 17 Arab MENA countries. Our results are also in harmony with
(Abu-Mhareb and Al-Fyoumi, 2011) who find that the macroeconomic factors are more important in
explaining economic growth than the financial development indicators in Jordan.
Table 3 reports the results of the Granger causality tests between economic growth and financial
deepening. The results indicate a bi-directional causal relationship between economic growth and
financial deepening when the financial deepening is measured by the total credit granted to the private
sector. However, the causality goes only from the economic growth to financial deepening when the
financial deepening is measured by the total bank deposits and the money supply (M2). Our results are in
agreement with Calderon (2002) who find a bi-directional causality between financial deepening and
economic growth in 109 developing and industrial countries using both the percentage of M2 to GDP and
the amount of bank credit granted to private sector to GDP as proxies of financial deepening. However,
our findings are contrasting with a recent study for (Abu Alfoul et al., 2014) who document a uniJournal
of Accounting and Finance Vol. 16(6) 2016 161
directional Granger causality from economic growth to financial development in Jordan when the
financial deepening is measured by the ratio of the credit granted to private sector to GDP.
Tables 4-6 report the results of the Johansen- Juselius conitegration test. The results show that
economic growth and financial deepening reach equilibrium at the long run. The statistics of both the
trace and maximum eigen tests are statistically significant when using any of the three proxies of financial
deepening. These findings are consistent with (Darrat, 1999; Apergis et al., 2007; Masoud and Hardaker,
2013) who provide evidence supporting the long run cointegration between financial development and
economic growth in a vast number of developed and developing countries.
Overall, the results of the study point out a statistically significant long run relationship between
economic growth and financial deepening. However, no apparent short term effect is documented
between the two variables. Indeed, this is expected in a developing country like Jordan where a gap exists
between the economic growth and financial development at the short run