The finance and growth nexus revisited: a truly Schumpeterian perspective

Abstract

The nexus between the financial system and economic development is an issue that is as important for economic theory as it is for economic policy. This article provides a theoretical and empirical analysis of the standard literature that uses Joseph A. Schumpeter as an academic patron. The starting point of our study is the theoretical finding that Schumpeter is misinterpreted in the finance and growth literature. We show that this leads to puzzling empirical results and difficulties in explaining even fundamental relationships. After a critical analysis of the literature, we provide our own empirical analysis using a panel of 43 countries to explore the relationships between finance and growth variables based on a truly Schumpeterian and thus monetary growth model. Our empirical analysis shows that (i) dynamic credit variables are better at describing the finance and growth nexus than static credit variables, (ii) as saving is not a prerequisite for credit, we do not find a statistically significant relationship between household saving and gross domestic product (GDP) growth, and (iii) in line with the empirical literature, we find a bi-directional relationship between credit and GDP growth.