A Test of the Impact of Financial Innovation on Economic Growth

The objective of this paper is to examine the empirical link between banking and financial system structure and economic growth, by constructing a cross‐country regression model using data over the 1970–1988 period, for a diverse set of countries. We extend the existing literature by explicitly examining the impact of measures of a country's financial deepness, in terms of second stage financial innovations, on a country's rate of economic growth. The cross‐country econometric results suggest that financial development (e.g., as measured by the presence of an organized financial futures market—a second stage innovation) is positively correlated with enhanced economic growth. Sensitivity analysis of the model indicates that the empirical findings are invariant to the inclusion of other variables often cited as determinants of economic growth.