Financial development, economic growth, and income inequality: A Toda-Yamamoto panel causality test

Abstract

This paper examines the causality between financial development, economic growth, and income inequality using panel data for 23 European Union countries over the period 1987–2017. The empirical study employs a trivariate setting of the Granger non-causality test based on the Toda and Yamamoto approach and uses several proxies of financial development to capture different dimensions of the banking system and stock markets. The findings reveal causal relationships between banking depth, economic growth, and income inequality. However, there are no causal relationships between banking efficiency and stability, stock market development, economic growth, and income inequality. Policymakers should focus primarily on economic growth to raise the demand for financial services in order to increase financial development and alleviate income inequality.