Abstract

This study analyzes the relationship between financial development and economic growth in Nepal using annual time series data from 1985 to 2016. The autoregressive distributed lag (ARDL) bound test approach estimated the cointegration form and long-run relationship. The results indicate that Nepal’s financial development and economic growth are cointegrated with bi-directional causality in the long-run, which suggests that they positively and significantly impact each other. The causal effects from financial development to economic growth are more potent than from economic growth to financial development. However, the speed of adjustment towards long-run equilibrium, directing from economic growth to financial development, is robust. There is a one-directional reverse causality from economic growth to financial development in the short-run. Based on these results, the study recommends that policymakers prioritize developing a well-functioning and effective financial sector to enhance economic growth, particularly in developing countries such as Nepal.

Key Words: Financial development, Economic growth, ARDL, Bi-directional causality, Nepal