THE IMPACT OF LIQUIDITY CREATION ON ECONOMIC GROWTH, VOLATILITY, AND ASSESSING ITS CYCLICALITY IN MENA COUNTRIES

Abstract

This thesis examines the impact of liquidity creation (LC) on economic growth (EG) and growth volatility (GV). It assesses its cyclicality in the Middle East and North Africa (MENA) region. LC is a core function of the banking system, and it is essential for economic growth and economic stability. However, the theoretical claim of the role and the effect of LC seems to be neglected in the literature, specifically in the context of developing countries. Studying the impact of LC on EG and GV in the context of MENA is crucial due to the region’s underdeveloped financial system and sensitivity to external shocks. Policymakers can use this knowledge to improve understanding and develop more effective monetary and financial policies. Based on this background, this study examines the impact of LC on EG and GV. Besides, it evaluates the moderating role of LC on the relationship between real shock and GV. It also examines the cyclicality of a core function of the banking sector. According to Berger and Bouwman’s (2009) LC measurement, to calculate the main independent variable, i.e., LC, the study includes 184 commercial banks listed in the capital market of 10 MENA countries.

The first objective of this thesis is to revisit the relationship between LC and EG in a panel of 20 MENA countries over the 2000-2019 period. Using pooled mean group estimations in a dynamic heterogeneous panel setting, this study shows that LC positively affects EG in the long run. However, the short-term effects were inconsistent due to banking fluctuations and crises in the sector, which cancelled out the positive impact of LC. The study’s findings align with previous research, which showed that LC positively impacts EG. Thus, LC could be a beneficial tool that can be used to promote EG.

Secondly, the study uses a panel cointegration estimating approach to discover the relationship between LC and GV. It evaluates the moderating effect of LC on the linkage between real shock, proxied by oil terms of trade volatility and GV. The study finds that LC significantly reduces GV in both the short and long run. The study also finds that both real and monetary shocks are the main sources of volatility and that LC helps to reduce the effect of real shocks and amplifies the effects of monetary shocks on GV. The study suggests that strengthening the banking industry through LC could be an essential strategy for avoiding economic swings and absorbing real shocks.

Finally, the study examines whether bank LC in the MENA region is procyclical and finds no research addresses whether it can exacerbate business cycle fluctuations. However, the study confirms that it is widely known that the supply of bank liquidity is closely associated with economic changes, which is referred to as procyclicality. There are several implications of the present study for future research and policymaking. It sheds light on how one of the primary banking operations affects economic development directly and indirectly and how it reacts to genuine shocks.