Financial Development and Economic Growth in Tanzania

Abstract

This study investigates empirically the causal relationship between financial development and economic growth in Tanzania. This study has three main objectives which include; to determine the relationship between financial development and economic growth in Tanzania; to determine the direction of causality between financial development and economic growth in the short-run and long-run; and to suggest policy recommendations based on the findings. The aim of this study is to provide the policy makers and the research community with knowledge of the relationship between financial development and economic growth. Unlike many previous studies, the study uses three proxies of financial development against Real GDP per capita growth (a proxy for economic growth). The three proxies for financial development include Broad money (M3) as a percentage of GDP, Domestic credit to the private sector as a percentage of GDP and Bank deposits as a percentage of GDP. This study used time series data from the period 1988 to 2012. This study investigates the relationship and causal link between financial development and economic growth in Tanzania by employing the Engle and Granger Co-integration test and the Granger causality test under a Vector Autoregression (VAR) framework. The results indicate the existence of a long-run relationship between all the indicators of financial development and economic growth. In addition, there is bi-directional causality relationship between financial development and economic growth in Tanzania in both the short-run and the long-run. The study therefore recommends that the current financial development in Tanzania be developed further in order to make the economy more monetized, ensure greater availability of monetary credit and holding of private bank deposits.