American Journal of Applied Mathematics and Statistics, 2014, Vol. 2, No. 4, 185-192 Available online at http://pubs.sciepub.com/ajams/2/4/2 © Science and Education Publishing DOI:10.12691/ajams-2-4-2 New Proxy of Financial Development and Economic Growth in Medium-Income Countries: A Bootstrap Panel Granger Causality Analysis Khalil Mhadhbi * Faculty of Economic Sciences and Management of Tunis *Corresponding author k_mhadebi@yahoo.fr Received April 11, 2014; Revised June 11, 2014; Accepted June 12, 2014 Abstract This paper examines the causal relationship between financial development and economic growth for 27 medium-income countries in the period 1970 to 2012. We develop a new proxy for financial development that refers to the input of real resources into the financial system and apply the panel bootstrapped approach to Granger causality. The results show, for three countries the findings support strong evidence on supply-leading hypothesis which implies that financial development induces economic growth and for six countries the findings support strong evidence on demand-following. Our results confirm for twenty one countries suggesting that their financial development does not depend on economic growth. Keywords: causality, financial development, economic growth, bootstrapping, panel data Cite This Article: Khalil Mhadhbi, “New Proxy of Financial Development and Economic Growth in Medium-Income Countries: A Bootstrap Panel Granger Causality Analysis.” American Journal of Applied Mathematics and Statistics vol. 2, no. 4 (2014): 185-192. doi: 10.12691/ajams-2-4-2. 1. Introduction Economists hold opinions of the role of finance in economic growth and the developed theoretical literature mirrors the divisions. The question of whether or not financial development affects economic activity has attracted a lot of attention in previous and current research (Kirkpatrick, 2000; Ang, 2008; Murinde, 2012). Bagehot (1873) and Hicks (1969) argued that financial system played a critical role in igniting industrialization in England by facilitating the mobilization of capital for “immense works.” Schumpeter (1934) emphasized the importance of the banking system in economic growth and highlighted circumstances when banks can actively spur innovation and future growth by identifying and funding productive investments. With the contributions of McKinnon (1973) and Shaw (1973), the relationship between financial development and economic growth has been an important issue of debate, and during the last thirty years these studies have fostered a fresh research interest in this relationship. Recent empirical studies, however, offer contradictory evidence (Kaminsky and Reinhart, 1999; Deidda and Fattouh, 2002; Wachtel, 2003; Favara, 2003; Rousseau and Wachtel, 2011and Arcand et al., 2012). In addition, the direction of causality still remains divisive. In summary, three schools of thought are identifiable in the extant literature: supply-leading response school of thought which argues that financial development leads to economic growth pioneered by Schumpeter (1911) and confirmed by notable studies such as Rajan and Zingales (1998), Levine et al., (2000) and Bittencourt (2012); demand-leading school of thought supported by studies such as Odhiambo (2004), Liang and Teng (2006) and Zang and Kim (2007) and Odhiambo (2008) which argues that growth leads to financial development; and bidirectional school of thought grounded by the studies such as Wood (1993), Demetriades and Hussein (1996), Akinboade (1998), Luintel and Khan (1999), Rousseau and Vuthipadadorn (2005) and Apergis et al., (2007) which submits that there is a bidirectional causality between financial development and economic growth. This shows that a consensus on the role of financial development in the process of economic growth does not so far exist. Unfortunately, there is no simple procedure to determine which view is empirically adequate – not even one that would rule out some views as obviously false. First, the factors that govern economic growth admittedly include many others besides financial development, and interactions among them are likely to prevail. Second, mutual causation, which in economic growth may be the rule rather than the exception, makes it difficult, if not impossible, to rule out a specific hypothesis. Third, the existing data on financial development are plagued by poor reliability and dubious validity. Thus, the existing econometric studies do not really rule out any of the main hypotheses; significant results can be cited for any of them. Consequently, the current verdict on the relationship between financial development and economic growth and their causality has remained inconclusive. However, the discussion focuses on measures of financial development, which must move literature because most authors only