Financial development, real sector output, and economic growth

This paper evaluates the interdependence between financial development and real sector output and its effect on economic growth. Using a panel data of 101 developed and developing countries over the period 1970 to 2010, we show that the effect of financial development on economic growth depends on the growth of private credit relative to the real output growth. The findings also suggest that the effect of financial development on growth becomes negative, if there is a rapid growth in private credit not accompanied by a growth in real output. Our findings provide empirical evidence in support of the theories postulating the existence of the optimal level of financial development given by the characteristics of an economy.