Nonlinear Effects of Financial Sector Development on Iran Economic Growth: With an Emphasis on the Role of Interest Rate

Abstract

In this paper, a threshold error correction approach is used to analyze whether in various interest rate regimes, the effectivity of financial development indicators on economic growth rate is different or not. Over the period 1973 – 2007, we show that in high interest rate regime, stock index’s growth rate and growth rate of banking facilities indicator (as financial development indicators), have positive effect on Iran economic growth.Nevertheless, in low interest rate regime, financial development reduces Iran economic growth. Basically this negative impact can be attributed to negative real interest rate due to high inflation. Furthermore we question whether financial index growth will equally affect economic growth before and after crossing a threshold level. Our results suggest that when threshold variable is considered as banking facilities index, there is no linear relationship between the mentioned index growth and economic growth. However, when the stock index is considered as a threshold variable, passing the threshold level will promote economic growth.