Jarita Duasa (International Islamic University Malaysia)
The financial sector, the money and capital market has developed so much to the extent that it has been said as being in the transition continuously and there is always a demand for it. The financial system keeps changing and within a year, various types of new financial tools being introduced in the market. Moreover, the size of transaction taking place is so large, that it could affects the economy positively. If financial development causes economic growth, this is in line with the “supply-leading” views, whereas if economic growth that causes financial development then it is suitable with the “demand-following” views. Focusing on OIC countries, the study aims to investigate the impact of financial development on economic growth or vice versa, in respective countries. In particular, the study analyzes the relationship between financial development (measured by credit to the private sector or deposit liabilities) and per capita real gross domestic product (GDP) using the widely adopted Granger causality test and the more recent Toda and Yamamoto’s (1995) non-causality test to establish the direction of causation between the two variables, besides other controlled variables. Additionally, we adopt an innovation accounting by simulating variance decompositions (VDC) and impulse response functions (IRF) for further inferences. Data collected are ranging from 1960-2005 for each country and only countries which have sufficient (minimum of 30 years) are selected and used in the analysis. Base on this, we select the following countries in this study: Bahrain, Egypt,Jordan, Kuwait, Libya, Malaysia, Pakistan, and Saudi Arabia. The results of study indicate that majority of Muslim countries’ financial development is attributable to their economic growth or economic performance. This is mainly support the “demand-following” views that economic growth causes financial development.
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