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Does finance lead or lag economic growth ? the Malaysian evidence

Hakim, Idwan and Masih, Mansur (2016): Does finance lead or lag economic growth ? the Malaysian evidence.

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The focus of this paper is to investigate the lead-lag or the causal relationship between financial development and economic growth in Malaysia. There are two alternative views – supply-leading and demand-following. Supply-leading view argues that finance leads to growth, while demand-following hypothesis contends that economic growth creates increasing demand for financial services. Since Malaysia is a small, highly open economy, the analysis takes into consideration development in trade openness. The paper applied the standard time series techniques on annual data incorporating cointegration tests, vector error correction models, variance decompositions and impulse response functions. Our findings offer support for the presence of long run relationships between finance and growth in Malaysia. Furthermore, the results consistently support the demand-following hypothesis for Malaysia. In other words, economic growth tends to lead financial development. This is in line with the findings of Ang and McKibbin (2007), which also found support for the demand-following hypothesis in Malaysia. The findings, in general, concur with the roles that the Malaysian financial sector has played in enabling growth performance. Going forward, more effective intermediation process, better allocation of resources to highly productive sectors, and more inclusive financial services may transform the roles of the financial sector from being a facilitator and enabler of growth, to a driver and catalyst of economic performance.

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