Financial sector development and threshold effect of inflation in ECOWAS and SADC: A Panel smooth transition regression approach

The financial sector of an economy is now widely agreed to constitute a potential important channel for growth. Many regions such as Sub-Saharan Africa, however, have relatively underdeveloped financial sector. Although several policy designs have been used to induce growth in the sector, there has been little or no success in the majority of the countries in the region. Existing theories suggest that inflation has negative effects on financial development. Other theories argue that inflation has a threshold effects on financial development. In this study, we provide a comparative study on the threshold effects of inflation on financial development between the Economic Community of West African States (ECOWAS) and the Southern Africa Development Community (SADC) for the period 1980-2011 using a novel Panel Smooth Transition Regression. Our results suggest evidence of the existence of a robust single threshold of inflation in both regions. Particularly, it indicates 17.9% and 14.5% of inflation for ECOWAS and SADC respectively, suggesting that inflation above these thresholds presents statistically significant detrimental effects for financial development in both regions. The study therefore argues that price stability policies with inflation targeting framework should be the primary objective in monetary policy, since high inflation is economically costly to financial development of the two regions.