Trade Openness and Financial Development in the New EU Member States: Evidence from a Granger Panel Bootstrap Causality Test

Abstract

The goal of this paper is to investigate the causality between trade openness and financial development in 11 new member states in the European Union. We employ a Granger bootstrap panel approach based on seemingly unrelated regressions, which accounts for cross-sectional dependence and slope heterogeneity among the countries in the panel. The main findings are as follows. First, the test results of the finance-trade nexus are country specific. Second, statistically significant causality is found from trade to finance in eight countries (Bulgaria, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Slovenia). As the regression coefficients are predominantly negative, the demand-following hypothesis on the finance-trade nexus is not supported in the majority of the countries. Third, finance is found to be a statistically significant Granger cause of trade in six countries (Croatia, Estonia, Latvia, Lithuania, Poland, and the Slovakia), and in four of them (the smaller ones: Croatia, Estonia, Latvia, Lithuania), the regression coefficients take positive signs, which support the supply-leading hypothesis.

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