The International Journal of Business and Finance Research ♦ VOLUME 7 ♦ NUMBER 5 ♦ 2013 61 FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH: EVIDENCE FROM GHANA Michael Adusei, Kwame Nkrumah University of Science and Technology, Ghana ABSTRACT The paper employs cointegration, Fully-Modified Ordinary Least Squares (FMOLS), Error Correction and the Generalized Method of Moments (GMM) techniques to investigate the relationship between economic growth and financial development using annual time series data (1971-2010) from Ghana. Three measures of financial development are used: domestic credit as a share of GDP; domestic credit to private sector as a share of GDP and broad money supply as a share of GDP. Evidence from our data suggests that financial development undermines economic growth in Ghana. The paper, therefore, cautions against financial liberalization in Ghana. JEL: G20, D90, E02, E44, C13, C22 KEYWORDS: Ghana, Financial Development, Economic Growth, Credit, Size of Government INTRODUCTION heoretically, Schumpeterian authors as well as some neo-Keynesian authors have unequivocally trumpeted the banking system's ability to create money and channel it into productive and innovative uses (Graff, 2003). Schumpeter (1911), in particular, submits that a well-developed financial system has the potential of catalyzing technological innovation and economic growth through the provision of financial services and resources to those entrepreneurs who have the highest probability of successfully producing innovative products and processes. The predominant mantra reverberating in the arena of the finance- growth nexus is that a more developed financial sector provides a fertile ground for the allocation of resources, better monitoring, fewer information asymmetries, and economic growth (Shen and Lee, 2006). Summary of the theoretical literature suggests that there are four possibilities regarding the causal relationship between financial development and economic growth (Apergis et al., 2007). The first hypothesis, called supply-leading response hypothesis, argues that financial development causes economic growth (Schumpeter, 1911, McKinnon, 1973; Shaw, 1973). The second hypothesis called demand-following response hypothesis posits that economic growth causes financial development. It argues that the development of the real sector stimulates demand for financial services that are passively met by the introduction of new financial institutions (Odhiambo, 2010). The third hypothesis is mutual impact which argues that there is a bi-directional causal relationship between finance and growth (Demetriades and Hussein, 1996; and Greenwood and Smith, 1997). The fourth hypothesis is no-causal relationship hypothesis which argues that there is no causal relationship between financial development and economic growth (Graff, 1999; Lucas 1988). In particular, Lucas (1988) rejects the existence of a finance-growth relationship, arguing that "economists badly overstress the role of finance in economic growth.” Most of the empirical studies on the finance-growth nexus have relied mainly on the cross-sectional and panel data (Saci, et al. 2009; Fernadez and Galetovic, 1994; King and Levine, 1993). However, there is a budding notion that conditions are a significant factor in the determination of the finance-growth nexus. Arestis and Demetriades (1997) assert that cross-section regressions do not reflect individual country T