The Role of Financial Development in Economic Growth-Inflation Nexus: Evidence from Iran

Abstract

It is widely known that high rates of inflation are detrimental to economic growth performance directly. However, much less attention exists about the mechanism in which inflation affects growth by financial development as an indirect channel. The main contribution of this paper is to estimate the effects of financial development and inflation on growth. The data availability permit us to cover the period between 1965 and 2011 for Iran. The results of 3SLS estimation show that, financial development is viewed as an important channel through which inflation can adversely affect growth. Also, the level of financial development is strongly associated with per capita GDP growth and openness. The results of Engle-Granger causality test confirm the existence of bidirectional causality between economic growth and financial development indicator. Furthermore, investment as a share of GDP, financial indicator and population act as influential factors on economic growth.

Keywords: Inflation, Growth, Financial development, Iran