Islamic financial depth, inflation, interest rates, and economic growth in Saudi Arabia: An application of vector autoregression model

Abstract

This study investigates the short-run dynamics among Islamic financial depth, interest rates, inflation, and their impact on Saudi Arabian economic output using quarterly information spanning 2017–2023. The study employed a vector autoregressive model due to the non-cointegrated nature of the variables. Results indicate positive short-run relationships between the current GDP per capita and its lagged value, and between economic growth and inflation. Conversely, interest rates demonstrated a negative short-run relationship with economic growth, while Islamic financial depth showed a positive but lagged impact. Wald tests confirmed short-run causality from inflation, interest rates, and Islamic financial depth to GDP. These findings suggest that keeping inflation in check with good central bank policies is important for stable markets and a growing economy. Furthermore, the size of the Islamic finance sector in Saudi Arabia seems to boost the country’s economy. The findings provide useful information for Saudi Arabian decision-makers in government and Islamic financial institutions.

Keywords

• economic growth
• Islamic financial depth
• Johansen cointegration
• Saudi Arabia
• VECM
• Wald test