A Startling New Empirical Finding on the Nexus Between Financial Development and Economic Growth in Kenya

Abstract

The recent global financial crisis has plunged the Kenyan economy into a substantial economic contraction that has created massive currency depreciation, falling production across most sectors of the economy, reductions in international demand, and stagnation in the tourism industry. It is in reference to these episodes that this study aims to investigate whether the long-run financial development and economic growth prospects of the Kenyan economy have been affected, and to determine empirically the explanatory variable(s) responsible for the slowdown in Kenyan economic growth. To achieve this, we measure the short-run and long-run impact of financial development on economic growth using time series data from 1980 to 2011. The ARDL bounds-testing approach to cointegration was applied because of the I(0) and I(1) nature of the data. Similarly, the U test of Mehlum and Sasbuchi was used for the first time to determine whether the variables had a monotonic or non-monotonic relationship. The finding of the study established that financial development has no contributory effects on Kenyan GDP in both the short-run and the long-run and this is immaterial to the course of the financial crisis. Trade openness was consistently discovered to be the greatest impediment to the improvement of Kenyan economic growth due largely to its negative and insignificant impacts on GDP in both the short-run and the long-run. The study equally discovered that the relationship between finance and GDP is monotonic, meaning that there is no excessive monetary dilation in the Kenyan economy. The most startling empirical finding of this study is that the GDP of continents with evidence of the demand-following hypothesis, as in the case of Kenya, has the fastest error correction model readjustment possibilities despite the crisis and other prevailing macroeconomic vices. The question of why and how opens up another area of empirical research.

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