ENHANCE THE LINK BETWEEN FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH: INSIGHTS FROM A GMM-VAR APPROACH

Abstract

This research investigates the complex interplay between financial development and economic growth within the Middle Eastern context, employing an advanced Generalised Method of Moments (GMM) Panel Vector Autoregressive (VAR) approach. Utilising panel data spanning 12 Middle Eastern economies from 2000 to 2018, the study conducts an empirical evaluation of the bidirectional causality between financial markets and economic expansion, incorporating a structural break analysis to assess the impact of the Arab Spring on this relationship. The investigation utilises the Financial Institutions Index (FII), Financial Market Index (FMI), and Broad Money Supply (M3) as key independent variables to examine their effects on real per capita GDP growth (CGDP). Findings indicate that, following 2010, financial institutions exerted a more pronounced negative influence on economic growth compared to financial markets, primarily due to inefficiencies in credit allocation, banking sector concentration, and weak financial intermediation. The Chow Test validates the presence of a structural break post-2010, necessitating a segmented analysis of the pre- and post-Arab Spring periods. Furthermore, the Granger Causality Test identifies a unidirectional causal relationship from financial markets to economic growth before 2010, whereas, in the post-2010 period, a bidirectional link emerges between financial institutions and economic expansion, lending support to the endogeneity hypothesis. The Impulse Response Function (IRF) analysis further highlights the volatility of financial market shocks, which initially stimulate growth but subsequently contribute to instability.  The study underscores the imperative of financial sector reform, with particular emphasis on enhancing banking efficiency, optimising credit distribution mechanisms, and expanding capital markets to ensure financial development translates into sustained economic advancement. The research offers policy recommendations for financial regulators, advocating for the reinforcement of financial infrastructure to mitigate systemic risks and strengthen economic resilience.