The role of the financial sector in the UK economy: evidence from a seasonal cointegration analysis

Abstract

This article empirically investigates the relationship between stock market/banking sector development and economic growth by controlling for the effects of human and physical capital factors in a seasonal cointegration framework. We use a sample of quarterly and seasonally unadjusted data which covers the period 1965Q1–2011Q4. The results suggest that: (1) the UK financial sector development is a good promoter of the domestic economy both in the long- and the short-run; (2) the supply-leading hypothesis that causality runs from stock market capitalisation and stock market volatility to real GDP per worker is confirmed; (3) stock market volatility has a negative influence on the UK’s output, which may reflect economic ambiguity but may also reflect a well-functioning and efficient stock market; (4) if a country has a good infrastructure and a well-educated nation, it enhances economic growth as well as betters the financial sector (i.e. markets and banks); and (5) if a new global financial meltdown is formed, this can easily devastate the UK economy.