The Effect of Financial Liberalization on Economic Development in Ethiopia
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Date
2016-01
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Addis Ababa University
Abstract
Financial Liberalization emphasizes on the leading role of market forces in the financial sector of
the economy and it is one of the debatable issues in the world economy. However, it is far from
clear how financial liberalization actually affects the economy in general and the financial system
in particular. Thus, this study aims to empirically examine the impact of financial liberalization on
economic development in Ethiopia over the period of 1984-2014. In doing so, the ARDL approach
to Co-integration and Error Correction Model were employed to investigate the long run and short
run relationships. Accordingly, the empirical results obtained from the study indicate that financial
widening has contributed significantly to the increase in saving and the level of economic growth.
Even though, the total deposit happens to generate more investment; there is shortage of supply of
credit. In addition, the study indicates financial widening and credit to the private sector exhibited
a significant positive association with financial development while total banks credit bearing a
significant impact on industrial development. However, the overall financial reform showed
insignificant association both with economic growth and industrial development. The efficiency in
allocating financial resources show significant positive association with share of banks credit to
the private sector, however, the overall financial reform has positive insignificant impact on
efficiency of resource allocation. The contribution of financial sector after the deregulation has a
mixed result on welfare. In terms of catalyzing employment opportunity, financial widening and the
overall liberalization policy measure have played a positive role while the financial development
has no significant impact on employment creation. Financial widening has significant positive
impact on poverty alleviation while the overall policy measure has insignificant impact on the
impoverished. Consequently, the result of the study indicate the overall financial liberalization
measure actually decrease the likelihood of financial instability and indicates the direction of
causality going from economic growth to financial development proving the demand leading
hypothesis, which in turn portrays the heavy involvement of government in the financial sector.
Key words: Financial liberalization, Financial liberalization index
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Keywords
Financial liberalization, Financial liberalization index