Study the Role of Macroeconomic stability Budgetary Indices on Financial Development-Economic Growth Nexus in Iran

The development of the financial system in all economies is one of the challenging issues that has been raised by economists in different decades. According to the World Economic Forum (2012), financial development refers to the factors, policies, and institutions that lead to efficient financial intermediaries and markets and deep and wide access to capital and financial services. Also, according to the latest report of the forum, creating an efficient, resilient and fair international financial system can support customers and activate savings and investment, which in turn can lead to economic growth and the creation of jobs and businesses in the economy. In fact, the financial system is the cornerstone of economic activities, but during the last decade, important steps have been taken to develop it (World Economic Forum Report, 2019, p. 22).According to the results of previous studies, a higher growth rate can be expected from any country that has a more efficient financial system (Dadgar and Nazari, 2009, p. 2). However, despite much evidence to support the positive impact of financial development on economic growth, there is still no consensus on the relationship between the two. In general, there are two main schools of thought on this subject. Proponents of the first school of thought argue that financial development is essential for economic growth (Goldsmith, 1969; Levin, 1997; and McKinnon, 1973). In contrast, proponents of the second school of thought, who are predominantly neoclassical theorists, argue that the financial sector is not the main driver of growth (Robinson, 1952; Wijnberg, 1983; Buffie, 1984; Lucas, 1988 and Shan, 2005). Among some researchers such as Patrick (1966), the existence of a two-way causal relationship and others such as Singh (1997), Andersen and Tarp (2003), Ayadi et al. (2015) and Ductor and Grechyna (2015), have found an inverse relationship between financial sector development and economic growth.

Indeed, although most empirical studies in this area confirm the positive impact of financial development on economic growth and show a one-way relationship between financial sector development and the real sector of the economy, but by reviewing the existing literature, it can be inferred that the relationship between these two macroeconomic variables is not definite. So, assuming a one-way causal relationship from financial development to economic growth can provide misleading results from the relationship between these two variables. In addition, according to the existing literature, different results on the causal relationship between these two key variables are affected by the pillars of financial development, and among the pillars of financial development, financial stability is one of the most key conditions for maintaining the relationship between financial development and economic growth.Financial stability refers to situations in which financial crises or external shocks do not generally disrupt the core functions of the financial system. This requires a disciplined government with a stable budget structure that can stabilize the macroeconomy and ultimately provide the conditions for financial stability in the economy. It should be noted that the issue of the impact of budgetary stability indicators as a measure of financial stability on the causal relationship between financial development and economic growth is one of the issues that have not been addressed in previous studies. Actually, despite the fact that the relationship between financial development and economic growth has been considered in numerous studies, but the study of how the relationship between these two macroeconomic variables is affected by macroeconomic stability budget indicators has not been considered so far.

Therefore, the purpose of this article is to study the effect of budgetary stability indicators in the expenditure sector on the causal relationship between financial development and economic growth. For this purpose, first considering financial development as a multidimensional index and considering the bank-based financial system in Iran, seven indicators of financial development in the banking sector have been used and then the multidimensional index of financial development using principal component analysis technique (PCA) has been calculated. Then, the causal relationship between the multidimensional index of financial development and economic growth has been analyzed using the bi-variate causality technique based on the vector error correction model (VECM) during the period 1357-1397. Finally, the effect of macroeconomic stability budget indicators on the causal relationship between these two variables has been studied using the tri-variate causality test based on the above model.

The results of our estimation show a one-way causal relationship from financial development to economic growth. The findings also indicate that the causal relationship between financial development and economic growth is affected by budgetary stability indices. Although the ratio of government debt to central bank, government debt to banks and non-bank financial institutions ratio and current expenditure ratio to GDP, have been able to maintain this direct causal relationship, but in other cases the negative significant impact of these indicators on the causal relationship between these two variables has been confirmed. In other words, the main results of this study show that the performance of government in the expenditure sector (except for three of these indicators) has led to the passivity of the financial sector to the real sector of the economy. Among the important reasons for such results are the short time horizon of governments’ plans, lack of serious efforts to reduce dependence on oil revenues due to the existence of high rents for some stakeholders and the lack of use of new financing methods for the budget deficit.