The Role of the Financial Sector in the Turkish Cypriot Economy: Evidence from Bounds and Causality Tests

Abstract

This paper investigates the link between financial development and economic growth in a small island economy, North Cyprus. Bounds testing approaches as well as causality techniques are conducted for analyzing an extended version of the augmented Solow growth model over the period 1977–2010. The empirical results suggest that investments in the financial and banking sectors are important drivers for real income growth in both the long and short terms of the North Cyprus economy. The findings also show that private credits in the financial sector do not cause output growth in either the long- or the short-term periods. The impact of physical capital for real income is not also found to be as strong as that of human capital in the case of the North Cyprus economy.