This study empirically examines the dynamic relationship between financial development and economic growth in Nepal using annual time series data from 1985 to 2016. The financial development is measured by domestic credit to the private sectors, domestic credit to the private sectors by banks, broad money (M2) and net domestic credit, separately. All are ratios to GDP. The economic growth is measured by real GDP per capita. The bound test approach of cointegration under autoregressive distributed lag (ARDL) model reveals that Nepal’s financial development and economic growth are cointegrated with bi-directional causality in the long-run. Thus, the study concludes that financial development and economic growth positively and significantly impact each other. The causal effects running from financial development to economic growth are portent then economic growth to financial development. However, the speed of adjustment towards long-run equilibrium, directing from economic growth to financial development is reasonably robust. There is one-directional reverse causality running from economic growth to financial development in the short-run. Therefore, the study suggests policymakers to prioritize policies to develop a well-functioning financial sector to enhance economic growth, especially for developing countries like Nepal.
G21, C22, F43, O11, O16