Financial development and economic growth: the inflation threshold effect

Although financial development seems to have a vital positive impact on the economic growth, some studies indicate that the ability of the financial sector to allocate resources efficiently depends on the inflation rate. The main object of this paper is to investigate whether the inflation threshold effect has any impact on the relationship between financial development and the economic growth, applying TAR model for a group of MENA countries. The results reveal two inflationary regimes in Egypt, Morocco, and Iran and three in Algeria. Afterwards, the effect of financial development on economic growth for each inflationary regime is estimated using nonlinear models. The findings imply that, unlike low inflation periods, in high inflation regimes, financial development has either no significant or a destructive impact on the growth rate. The findings support the view that for countries experiencing relatively high inflation rates, pursuing financial reform would not lead to economic growth.