Title:
THE DIRECTION OF CAUSALITY BETWEEN FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH IN TANZANIA: AN EMPIRICAL ANALYSIS

Authors:
Erasmus Bernald Hyera, Felician Mutasa

Abstract:
This paper examines causality relationship between financial development and economic growth in Tanzania over the period 1980 to 2012. In time series context, recently econometric techniques were used; namely Augmented Dickey and Fuller test (ADF) for unit roots test, Johansen test for Co-intergration test, Vector error correction model (VECM) tested for short run and long run causality, a pairwise Granger causality test used to establish the direction of causality and Variance decomposition (VD) under VAR framework applied for validating strengths of findings outside the estimated sampling period. In overall empirical findings can be summarized as follows. Firstly, there is long-run relationship between financial development and economic growth. Secondly, granger causality test suggests economic growth causes financial development in a short-run when broad money to nominal GDP and liquidity liability to nominal GDP used, however when credit to private sector to nominal GDP was used findings confirmed evidence of bidirectional causality between financial development and economic growth, and in a long-run causality run only from Economic growth to financial development even in outside the estimated sampling period. Thirdly, financial sector has been effective in promoting economic growth in a short run only and economic growth variable was the most exogenous leading variable than others suggesting, financial sector has played little role in promoting economic growth in Tanzania. Lastly, capital accumulation channel via gross domestic investments to nominal GDP links financial development and economic growth in a short run only, suggesting long-term financial infrastructures that are necessary for successful promoting investments for spurring economic growth still remain weak in Tanzania. These findings are contrary to the convectional results favored only supply view. Although study has confirmed mixed results on the direction of causality between financial development and economic growth in Tanzania ,in view of feedback effect results, study recommend more efforts should be devoted to the deepening of financial sector by enhancing competition, improving business environment, investing on human resources and legal environment.