Role of consistent regime-specific policies in recovering the negative relationship between financial development and economic growth

This synopsis empirically showed that the negative relationship between financial development and economic growth can be reversed through consistent policies in Pakistan. To empirically test this argument, the study utilized the data between 1977 and 2022 from the World Bank’s World Development Indicators, the Pakistan Economic Survey, and the Annual Reports of the State Bank of Pakistan. Markov switching methodology was used to capture the regime-specific impact of financial development on economic growth. The novelty of this study lies in the investigation of the role of regime-specific and consistent financial sector policies in recovering the positive finance–growth nexus. Stable and consistent financial sector policies are pivotal to reversing the adverse impact of financial development on economic growth because spurts and reversals in financial and real sector policies hindered the economic growth process in Pakistan. Notably, the findings suggest that the finance–growth relationship depends not only on macroeconomic variables but past performance of the financial sector is an important incentive. Besides, the results reveal that the inflation rate deters economic growth. The study found that the contemporaneous effect of financial development on economic growth is negative and it turns out to be positive after two years. This confirms the nonlinearities between the financial development and economic growth relationship in Pakistan. To this end, policymakers may consider the lag effect while designing financial sector policies.