Does inflation affect asymmetrically to financial development in India? Fresh insights based on NARDL approach

Abstract

PurposeThis study examines the possibility of asymmetric impact of inflation on the financial development (FD) in the case of Indian economy from 1980 to 2020. Moreover, the finance–growth hypothesis is also tested.Design/methodology/approachThe authors incorporated the “Nonlinear Autoregressive Distributed Lag” (NARDL) model due to Shin et al. (2014) to investigate the asymmetric impact of inflation on financial development. Asymmetric cumulative dynamic multipliers are also used to track the traverse of any short-run distortion towards the long-run cointegration.FindingsThe results revealed that inflation impacts the financial development negatively whereas the economic growth (EG) and trade openness have a positive effect. However, the effect of inflation on financial development is not symmetric. Moreover, the findings support the demand-led growth hypothesis.Originality/valueTo the best of the authors' knowledge, this is the first study examining the asymmetric effects of inflation on financial development in the Indian context. In addition, instead of using a single proxy to measure financial development, an index for financial development encompassing different aspects of the financial system has been incorporated.Peer reviewThe peer review history for this article is available at: https://publons.com/publon/10.1108/IJSE-02-2023-0094

Revisiting the financial development and economic growth nexus: empirical evidence from SAARC countries

“…4.2 Principal component analysis Ang and McKibbin (2007) state that the finance-growth relationship is sensitive to the measurement of FD due to its multidimensional nature. In the measurement, the selection of one variable leads to variable bias, whereas the selection of more variables in a single regression model creates the problem of multicollinearity and degree of freedom (Dar and Nain, 2023). Therefore, to control the measurement bias and capture the multidimensional nature of FD, this study uses PCA.…”

“…The PCA results are presented in Table 3. Following the eigenvalue rule, the study uses the first PC because it has an eigen value significantly greater than one, and more importantly, this component explains 93.6% of the total variation of the variables (Dar and Nain, 2023). Thus, the values of the first eigen vector are used as factor scores or weights for the construct (IFD).…”

“…However, the type of impact between inflation and FD is not discussed entirely in the empirical literature. This is because the influential studies of Rousseau and Wachtel (1998), Boyd et al (2000); Hung (2003); and Dar and Nain (2023) provide the empirical basis for the widely supported inflation has a negative impact on FD, but Kim and Lin (2010) and Ehigiamusoe et al (2022) show that these results may also be indirect, meaning that inflation may decrease the positive impact of EG on FD.…”

“…New banks, insurance companies and other financial institutions will emerge to meet this growing demand. Consequently, this leads to FD by enlarging the size and technical innovations within the financial sector (Ehigiamusoe et al, 2022;Dar and Nain, 2023). Moreover, an increase in EG leads to expansion in the financial sector by increasing the creditworthiness of firms and households due to stable increased EG (Sethi et al, 2020).…”

“…The selection of the variables for constructing IFD is mainly guided by Nain and Kamaiah (2014) and Dar and Nain (2023). The GDP deflator is used as a proxy measure for inflation and is also used in the studies of Batayneh et al (2021) and Dar and Nain (2023). The superiority of this measure is that it encompasses the pricing of all goods and services produced within a country's borders relative to other measures like (CPI and WPI).…”