Finance-Growth Nexus and Convergence

Abstract

This thesis revises the relationship between financial development and the economic growth, the finance-growth nexus. This thesis expands the existing literature by using more sophisticated measures to determine the level of financial development to get a more accurate impression on the effect it has on economic growth.

Economic growth has been a constant long-term trend in the recorded economic history. It can be decomposed to three elements: growth in labour, capital stock, and the total factor of productivity (TFP). The financial sector is mainly able to affect growth through the TFP, although it also plays a central role in enabling investment and thus growing the capital stock of the economy.

The primary function of the financial sector is to allocate the society's resources efficiently under uncertainty. It does so by performing its five basic functions: risk management, transfer of economic resources, corporate control, mobilization of savings, and facilitation of exchange.

I find that all benchmark variables describing financial development have got an effect on economic growth and convergence, depending on the situation and the type of examination. None of the variables show a consistent dominating effect, which supports using the variables as a group instead of solely relying on one of the selected variables.