The relationship between stock market development and economic growth : an illustration of European countries

Abstract

“One of the most important problems in the field of finance, if not the single most important one, almost everyone would agree, is the effect that financial structure and development have on economic growth” - Goldsmith, 1969, Pg. 390. This dissertation will examine the relationship between stock market development, bank advancement and economic growth present within the United Kingdom, France, Germany, Switzerland and Spain. Through the use of annual time series data, Granger Causality tests were run in order to indicate and analyse any causal links which may be found between economic growth and developments in the financial sector. Findings from this study indicate that the financial structure found within each of these countries does indeed play an important role in conditioning the direction of causality between developments in the stock market, advancements in the banking sector and growth within the economy. It is suggested that only those countries that experience a bank-based financial structure does a unidirectional relationship, between bank development and economic growth, exist. No such evidence in this regard was found in the cases of those economies with a market-based financial structure. In the cases of Germany and Switzerland, through the use of Granger causality tests, it is suggested that financial developments are caused by economic growth, while conversely, in the case of Spain, findings clearly indicate the opposite, that is, economic growth is the product of financial sector progression. Empirical evidence, in relation to the UK’s economy, reveals that a bidirectional bond is present between bank development and economic growth together with an even stronger unidirectional causal link flowing from stock market development to the growth of the economy. The findings for France indicate that bank development is the cause of economic growth while at the same time, such growth is seen to be the causal factor of stock market development.