FINANCIAL DEEPENING PROCESS AND DYNAMICS OF ECONOMIC DEVELOPMENT IN NIGERIA

Abstract: The finance-led growth hypothesis has sparked widespread controversies in both economics andfinancial literature on the effectiveness of the monetary policy transmission mechanism in driving the process ofdevelopment in low income countries. These controversies have focused on supply-leading and demandfollowing hypothesis with regard to the direction of causality between financial deepening and economicgrowth. Thus, this paper took the side of the supply-leading hypothesis and empirically examined how thedeepening of the Nigerian financial system shaped the process of economic development between 1981 and2018 with a focus on poverty reduction and income inequality. Annual time series data on the underlyingindicators of financial deepening and economic development were sourced from the Central Bank of Nigeria(CBN) Statistical Bulletin, National Bureau of Statistics (NBS) and the World Bank World DevelopmentIndicators (WDI). Econometrics techniques of autoregressive distributed lag (ARDL) model, KwiatkowskiPhillips-Schmidt-Shin (KPSS) unit root test approach and bounds cointegration test form basis for the analysis.It was found from the KPSS unit root test results that the variables are mixed integrated. Additionally, thecointegration test results revealed that long run relationship exists among the variables in each of the models.This prompted the rejection of the null hypothesis of no cointegration. The estimated ARDL model revealed thatbroad money supply as a ratio of GDP has significant negative effect on both poverty headcount and incomeinequality in the short run. Similarly, the long run result showed evidence of negative impact of ratio of broadmoney supply to GDP on both poverty headcount and income inequality. The negative effect of the ratio ofbroad money supply to GDP on each of the economic development indicators corroborates with the theoreticalexpectation and provides appreciable empirical evidence that growth in monetary aggregate is an importantchannel through which financial deepening fosters pro-poor growth and more equal income distribution.However, private sector credit is statistically insignificant in influencing poverty and income gap in both shortand long run. The result further revealed that real interest rate was found to exert significant positive impact onpoverty. This implication of this finding is that rising level of real interest rate undermines the deepening offinancing system and in turn exacerbates the poverty incidence. Given the findings, it is recommended that themonetary authorities, especially the CBN should continue to deepen the Nigerian financial system throughsustained increase in monetary aggregates and effective allocation of credits to critical sectors with highpotentials of flattening the curves of poverty and income inequality to boost economic development.

Keywords: Financial deepening, economic development, poverty incidence, income inequality, monetary policyand transmission mechanism