Does the stock market cause economic growth? Portuguese evidence of economic regime change ☆ Luís Miguel Marques a , José Alberto Fuinhas b, ⁎, António Cardoso Marques b a University of Beira Interior, Covilhã, Portugal b NECE and University of Beira Interior, Management and Economics Department, Estrada do Sineiro, Covilhã, Portugal abstract article info Article history: Accepted 11 February 2013 JEL classification: O10 C22 G10 Keywords: Stock market Economic growth Economic regime change Granger causality VAR The relationship between stock market and economic growth is tested for Portugal (1993–2011), which is a small open economy dependent on bank financing. The relationship between economic growth and bank financing is also appraised. Using Vector Autoregressive (VAR) modeling, Granger causality, variance decomposition and impulse response function are discussed. The physical replacement of the currency, as a consequence of the integration in the European Monetary Union, proves to be an economic regime change. The effect of the subprime crisis was also proved. There is evidence of Granger bidirectional causality between the stock market and economic growth. Meanwhile, there was no evidence of causality running from bank financing to economic growth. © 2013 Elsevier B.V. All rights reserved. 1. Introduction The relationship between economic growth and the financial system, whose components are stock markets and the banking system, has received considerable attention for decades (e.g. Beck and Levine, 2004; Capasso, 2008; Goldsmith, 1969; Keynes, 1973; Levine, 1991; Schumpeter, 1982). Traditionally, Anglo-Saxon countries use mainly the capital market for corporate financing, while in non-Anglo-Saxon coun- tries the banking system predominates (e.g. Marini, 2005; Lee, 2012). The use of long series as well as the control of structural changes might be important in determining the relationship between the fi- nancial system and growth. Given that structural changes may have the strongest impacts on a small economy, we will focus on Portugal. This exercise will allow us to verify the interaction of variables during the 1990s and 2000s, a period full of both economic and political change. Considering that Portugal is a non-Anglo-Saxon country, the banking system is expected to play a more significant role in the economy than the stock market. The analysis of the relationship between stock market and eco- nomic growth was extended by using Vector Autoregressive (VAR) modeling, controlling for economic regime change experienced in the Portuguese economy. That change is a consequence of joining the European Economic and Monetary Union (EMU), and it is econo- metrically controlled by using an exogenous variable, namely a shift dummy. The main questions of this study are: (i) will the stock mar- ket play an important role in Portuguese economic growth? and (ii) will the banking system therefore be influential in Portuguese economic growth? Both stock market development and the banking system are expected to play a positive role in economic growth. Results suggest that the stock market Granger-causes economic growth. However, this Granger causality is not verified from banking system to economic growth. This study allows us to better under- stand how to act in terms of economic policy for the financial system, focusing on the stock market segment or banking segment. This paper evolves as follows. Section 2 covers the literature review. Section 3 presents the data and model used. The results shown in Section 4 are discussed in Section 5. Section 6 concludes. 2. Literature review The relationship between the financial system and economic growth received increased interest from the 1990s (e.g. Levine, 1991; Pagano, 1993; Spears, 1991), due to Lucas and Romer's endogenous growth the- ory. In reality, research had already been conducted on this subject for several decades (e.g. Goldsmith, 1969; Gurley and Shaw, 1955; Keynes, 1973; Schumpeter, 1982; Shaw, 1973). We can divide the financial Economic Modelling 32 (2013) 316–324 ☆ Research supported by: NECE, R&D unit funded by the FCT — Portuguese Foundation for the Development of Science and Technology, Ministry of Education and Science. ⁎ Corresponding author at: University of Beira Interior, Management and Economics Department, Estrada do Sineiro, 6200-209 Covilhã, Portugal. Tel.: +351 275 319 600; fax: +351 275 319 601. E-mail addresses: jafuinhas@gmail.com, fuinhas@ubi.pt (J.A. Fuinhas). 0264-9993/$ – see front matter © 2013 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.econmod.2013.02.015 Contents lists available at SciVerse ScienceDirect Economic Modelling journal homepage: www.elsevier.com/locate/ecmod