Threshold effects in the finance–growth nexus: a dynamic panel GMM analysis

This study revisits the finance–growth nexus using panel data from 171 countries spanning 1980–2019. Its main contribution lies in applying a dynamic threshold GMM approach to five-year averages of financial development indicators, including the IMF Financial Development Indexes, credit, M2, market capitalization ratios, and standard covariates. Significant threshold effects are identified for the credit-to-GDP ratio, which is consistent with prior evidence. A novel finding is the identification of nonlinearities in the financial institutions’ depth and financial markets access sub-indexes. The findings challenge the “too much finance” hypothesis by showing that, although the marginal effect of finance on growth diminishes beyond these thresholds, it remains positive. Robustness checks across different country subgroups confirm these findings and highlight that the dynamics observed in emerging and developed economies are central to the emergence of full threshold effects. Overall, the findings have important policy implications, suggesting that optimal financial development strategies should be tailored to countries’ respective stages of economic development.