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ERC WORKING PAPERS

Financial Integration and Growth: A Nonlinear Panel Data Analysis

Duygu Yolcu Karadam and Nadir Ocal

Abstract:
This paper employs Panel Smooth Transition Models (PSTR) to examine the financial integration and economic growth relationship for a large panel data set consisting of 82 countries and for three subsamples, namely emerging, industrial, and developing countries, for 1970-2010 periods. Unlike linear specifications with interaction terms, PSTR models are flexible enough to endogenously determine how the degree of institutional quality, financial sector development, trade openness, budget deficit, inflation volatility and financial integration can have a role in revealing asymmetries in financial integration-growth nexus. Except developing countries, empirical results strongly indicate nonlinear dynamics and imply that the impact of financial integration on growth is asymmetric depending on the threshold effects of these variables which show great variation not only from variable to variable but also for different country groups. As far as whole set of countries is concerned, our findings imply that countries having developed financial systems, qualified institutions and stable macroeconomic environment seem to be benefiting from financial integration. Moreover, nonlinear threshold effects are more apparent and different for emerging countries compared to the industrial countries. Unlike former economies, higher levels of financial integration and trade openness decrease benefits from financial openness for the industrial countries. Besides, high fiscal deficit has more pronounced negative effect on the growth of the industrialized countries compared to emerging economies and other indicators. 

Full Text (in Adobe Acrobat format)

2014

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