The Bounds Test Approach for Co-integration and Causality Relationship between Financial Development and Economic Growth in Bangladesh

This paper empirically examined the supply-leading or demand-followinghypotheses in case of Bangladesh using time series data for the period of 1974 to 2009. The ADF and PP tests results support that all the variables are integrated of order 1. The ARDL bounds test results indicate that there exist three forms of longrun relationships between the variables. The Granger F-test results supports that the supply-leading hypothesis is accepted in Bangladesh economy indicates that at the preliminary stage of economic development in Bangladesh financial development causes the economic growth. It is also found that long-run elasticity of economic growth with respect to M2 is higher than short-run elasticity. Thus it can be said the new policy which is formulated by Bangladesh Bank for contraction money supply to control inflationary rate will be harmful for economic growth. The diagnostic tests results support that the model is well specified, and there are no problems of autocorrelation, heterpscedastcity, normality and ARCH in the model. The CUSUM and CUSUMSQ tests results support that all the coefficients in the error correction model are stable. Therefore policies about economic growth can be made based on the preferred model.