The main objective of this paper is to investigate the nature and direction of the causal relationship between financial development and economic growth for the specific case of Bolivia. This research also pretends to be a contribution to the sparse literature for the Bolivian case. To achieve these goals, this paper adopts a time series approach and performs Granger-causality tests within a cointegration and Vector Error Correction Model (VECM) framework. For this purpose, a pentavariate Vector Autoregressive (VAR) system is constructed using annual data for the period 1962-2009. The model is estimated twice with two different proxies of financial development: the ratio of credit to the private sector to GDP, and the ratio of Money and Quasi-Money (M2) to GDP. Economic growth is measured by GDP per capita, and three non-financial variables are also considered in order to control for omitted variable bias. Then, the Impulse-Response Function (IRF) and Variance Decompositions (VDCs) analysis are carried out. The empirical results support the existence of a stable long-run relationship between financial development measures and economic growth. After controlling for the set of non-financial variables, results show opposite causality patterns between the two models. There is evidence of a weak unidirectional Granger-causality running from credit to growth. There is also evidence for a unidirectional causality flowing from growth to M2. However, given that the two financial development proxies capture different dimensions of the financial system, the addition of the found causality patterns is taken as a broad bi-directional causality. In this sense, it is concluded that in Bolivia financial development matters for growth and viceversa. In line with the Schumpeterian and endogenous growth theories, it is further argued that financial development has the potential to play an important role in both the growth and economic development processes. It also represents a
possibility to absorb the benefits of growth. However, in Bolivia this linkage seems to be undermined mostly by structural factors. For this, policy should be mainly directed towards the improvement of financial markets, the legal framework, and the access to formal financial services.