Interest Rate Deregulation, Financial Development and Economic Growth: Evidence from Bangladesh

Abstract

This article analyses the relationship among interest rate reforms, financial development and economic growth by using annual dataset for the period covering 1980–2014 for Bangladesh. The effect of interest rate reforms on financial development is examined using a financial deepening model, and the causal relationship between financial development and economic growth is examined, by including deposit interest rate as a third variable, thereby forming a simple trivariate causality model. The empirical results of cointegration and error correction models show that there is a positive effect of deposit rate of interest rate on financial depth in Bangladesh. Besides, multivariate Granger causality tests reveal that there is only one-way causality between financial depth and economic growth—the flow running from financial depth to economic growth. In addition, the study finds there is bidirectional causality between deposit rate of interest rate and economic growth, which is also confirmed by the pairwise Granger causality test. The inference of this study is that a deregulated deposit rate of interest will raise financial depth and eventually enhance the economic growth of Bangladesh. Therefore, the financial reforms should be directed towards accomplishing a more deregulated deposit rate of interest for progressive growth in the economy of Bangladesh.