Financial Deepening and Economic Growth in Nigeria: An Error Correction Approach

Abstract

This study investigates the dynamic relationship between financial deepening and economic growth in Nigeria using an Error Correction Specification (ECS) framework. Motivated by the persistent disconnect between financial sector reforms and real sector productivity, the research employs time-series data covering 1980-2024. Methodologically, the study utilizes Augmented Dickey-Fuller and Phillips-Perron unit root tests, Johansen multivariate cointegration, pairwise Granger causality tests, and a Parsimonious Error Correction Model (PECM). The empirical findings provide robust support for the supply-leading hypothesis, revealing unidirectional causality from financial deepening proxies specifically broad money supply ratio (M2Y) and private sector credit (PRIVY) to economic growth. The Johansen cointegration results confirm a stable, long-run equilibrium relationship among variables, while the significant error-correction term indicates a steady annual convergence rate toward equilibrium following short-run shocks. Furthermore, while short-term monetary adjustments exhibit transient frictions, long-run estimates underscore that sustained financial depth and capital stock accumulation significantly enhance economic performance. Conversely, unmanaged population pressures and structural credit bottlenecks continue to hinder optimal output. The study concludes that financial deepening is a vital catalyst for Nigerian development, provided qualitative credit allocation and institutional efficiency are optimized. Policy recommendations emphasize targeted credit to productive sectors, enhanced asset quality management, and strategic infrastructure investment to transform financial depth into inclusive economic expansion.