Financial Development is Supply-Leading or Demand-following? Empirical Investigation on EU Countries

Abstract

This study investigates the complex relationship between economic growth and financial development in 14 European nations from 2002 to 2020. This study compares supply-leading versus demand-following financial evolution assumptions using panel co-integration analysis and vector error correction models. To fully understand financial progress, the research integrates multiple variables. A complex and intricate link is shown by empirical evidence. Short-term supply-leading features include GDP to stock market capitalization and private sector credit. However, monetary liability growth follows demand. The long-term relationship between economic growth and private-sector loans is negative. This study shows that the causal relationship depends on the financial development index used. Additionally, the study distinguishes between transitory changes and lasting equilibrium connections. The study also found a dynamic association between financial development and economic growth as an economy matures. The supply-leading concept states that supply drives the stock market in early development. However, as the economy grows, a demand-following pattern arises, supporting the contradiction. This study offers a deep knowledge of the complex relationship between financial development and economic growth in Europe. The research uses powerful econometric tools and financial development indicators to demonstrate the importance of nuanced understanding for good policy making.

Supply-leading,Keywords: Economic Growth, Financial Development, Demand-following,  Panel Cointegration, Vector Error Correction Model, Panel Causality