Stock markets, banks and economic growth : time series evidence from South Africa

Abstract

The objective of this paper is to examine the casual relationship between stock markets, banks and economic growth in South Africa using quarterly time series data from 1983:q1-2007:q4. The paper uses Vector Error Correction model (VECM) based causality tests to establish a link between financial development (represented by both banking and stock market systems) and economic growth. Impulse response functions (IRFs) and Variance Decomposition (VDCs) are computed to further examine the short-run dynamics among the variables in the system. Also, Structural Vector Auto regression (SVAR) is applied to examine the link between financial development and economic growth. This is achieved by following Blanchard and Quah’s(1989) technique to identify the components of residuals to recover the shocks based on endogenous economic theory The empirical investigation suggests that in the long-run, there is evidence of bidirectional causality between financial development and economic growth using the banking system proxy by Bank Credit to Private sector (BCP). While, when stock markets variables are used that is Turnover Ratio (TR) and Value of shares Traded (VT), the results indicate unidirectional causality from economic growth to stock market system. The Impulse response functions (IRFs) and variance decompositions (VDCs) indicate that financial development (BCP,TR, and VT) have short-run impact on economic growth at the immediate year of initial shocks and VDCs shows that all the indicators for financial development contain some useful information in predicting the future path of economic growth. Meanwhile, SVAR results indicate little evidence that finance promote economic growth in the long-run.

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