The Impact of Financial Development on Economic Growth in Kenya

Abstract

The debate on the direction of causality between financial development and economic growth has received great attention from scholars. This study examined the effect of financial development (FD) on economic growth (EG) in Kenya. The paper as well investigated the direction of causality between financial development and economic growth in Kenya. In order to accomplish the above study objectives, the study used Granger causality test to determine direction of causality. To determine the effect of financial development on economic growth in the sectors, the study used Pooled OLS, Fixed Effect random effect model. The study used panel data for the period 2007 to 2015, which was obtained from the Central Bank of Kenya (CBK). The results suggest a presence of a relationship from financial development to economic growth. However, economic growth does not affect financial development directly. This implies that financial development promotes economic growth in Kenya and that policies at enhancing the development of the financial sector can help to promote economic growth. The panel study shows that financial development affects the following sectors significantly; Construction, Wholesale and Retail, Information and Communication and Finance & Insurance. In addition, the study shows that the financial development variables affected sectoral growth negatively in the year 2007, 2008 and 2011. This is because of the political temperature at the time. This implies that financial development promotes economic growth in Kenya and that policies at enhancing the financial development of the different sectors can help to promote economic growth.