Supply-leading versus Demand-following Hypothesis: Empirical Evidence from Three SSA Countries

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Abstract

Abstract:  This study investigates empirically the direction of causality between financial development and economic growth in three sub-Saharan African countries — Kenya, South Africa and Tanzania. The study seeks to answer one critical question: Does financial development in sub-Saharan African countries exhibit a supply-leading or demand-following response? Using three proxies of financial development against real GDP per capita (a proxy for economic growth), the study finds that the direction of causality between financial development and economic growth is sensitive to the choice of measurement for financial development. In addition, the strength and clarity of the causality evidence is found to vary from country to country and over time. On balance, a demand-following response is found to be stronger in Kenya and South Africa, whilst in Tanzania a supply-leading response is found to be dominant. The study therefore recommends that for Kenya and South Africa the real sector of the economy should be developed further in order to sustain the development of the financial sector. However, for Tanzania, there is need for further development of the financial sector in order to make the economy more monetized.

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