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ESDS International Case Study

Title: Assessing the Link between Financial Liberalization and Saving

Author: Alexander E. Kentikelenis
Institution: University of Cambridge
Date: January-March 2009
Subject area(s): Economics
Relevance to other area(s): Development studies
Project type: Graduate coursework


Photo by: mtsofan, Creative Commons, Flickr.

In 1973, McKinnon and Shaw made the case against financial repression and spurred a world-wide debate with important policy implications. Repressed economies were seen to suffer from a variety of problems that could be amended by liberalizing the system and resorting to the market, instead of the government, to perform the most efficient allocation of resources. One of the main hypotheses in their work was that financial liberalization would allow the market to determine interest rates, which would in turn stimulate saving  and investments, thus giving rise to a virtuous cycle of saving and growth.

This study focuses on the effects of financial deregulation on gross national and household savings via its impact on interest rates. In this context the experiences of the United Kingdom and Korea after 1973 will be explored.

In these case studies, no clear link between financial liberalization and savings was established. In some cases there were correlations between a rise in interest rates and a similar rise in savings, but these were only limited to specific time periods. A liberalized system also allows the financial system to have a more cyclical effect on interest rates. The only relationship that appears clear is that deregulation has an adverse effect on household saving at least in the short-term.

Datasets used
Aims and objectives

To explore whether there is an effect by financial liberalization on savings through interest rates as R. McKinnon and E. Shaw hypothesized in 1973.


The study starts with a literature review and highlights the weaknesses of the McKinnon-Shaw work. Then it explores the link between financial liberalization and savings. In doing this, different variables that have explanatory significance vis-a-vis savings and interest rates are examined. With the help of statistics from ESDS databases (IMF, World Bank, OECD), it is shown that the effects of deregulation were not originally predicted by theory.

  • Link between financial liberalization and savings at best unclear: too many other variables intercept that hinder definite conclusions
  • Financial liberalization actually increases household access to credit, which in turn has a negative effect on personal savings; but this need not necessarily affect gross national savings.
  • The debate on the optimal pace of liberalization is useful, but it still needs to be acknowledged that liberalization should not be treated uncritically and as a one-size-fits-all solution for neither developed nor developing countries.
Additional information:

graph showing United Kingdom data
Data on M2 before 1982 and on deposit interest rates after 2000 missing from the IMF Financial Statistics and World Bank Development Indicators databases respectively. For this reason, after 1998 real deposit interest rates are replaced by real lending interest rates, which although indicating a similar trend will be slightly higher.

graph showing Korea data
Data on real interest rates before 1980 and on saving rates before 1979 missing from the World Bank Development Indicators and the OECD Historical Statistics databases respectively.


Interest Rate Definitions

  • Deposit interest rate: The rate paid by commercial or similar banks for demand, time, or savings deposits.
  • Real deposit interest rate: Calculated here using the Fisher equation; nominal deposit interest rate minus inflation rate as measured by the GDP deflator.
References and/or acknowledgements

Arestis, P. (2006) “Financial Liberalization and the Relationship between Finance and Growth,” in Arestis, P. and M.C. Sawyer, A Handbook of Alternative Monetary Economics, London: Edward Elgar
Arestis, P. and P. Demetriades (1997) “Financial Development and Economic Growth: Assessing the Evidence,” The Economic Journal, 107(May), pp. 783-799
Balassa, B. (1989) “The Effects of Interest Rates on Savings in Developing Countries,” World Bank Working Paper
Bandiera, O., G. Caprio, P. Honohan and F. Schiantareli (2000) “Does Financial Reform Raise or Reduce Savings?” The Review of Economics and Statistics, 82(2), pp. 239-263
Bayoumi, T. (1993a) “Financial Deregulation and Consumption in the United Kingdom,” Review of Economics and Statistics, 75(August), pp. 536-539
Bayoumi, T. (1993b) “Financial Liberalization and Household Saving,” Economic Journal, 103(November), pp. 1432-43
Blundell-Wignall, A. and F. Browne (1991) “Macroeconomic Consequences of Financial Liberalization,” OECD Working Papers No.98
Blundell-Wignall, A., F. Browne and S. Cavaglia (1991) “Financial Liberalization and Consumption Behaviour,” OECD Working Papers No.81
Chang, H.J. (2005) The East Asian Developmental Experience, London: Zed Press
Cho, Y.J. (1988) “The Effect of Financial Liberalization on the Efficiency of Credit Allocation: Evidence from Korea,” Journal of Development Economics, 29, pp.101-10
Darby, J. and J. Ireland (1994) “Consumption, Forward Looking Behaviour and Financial Deregulation,” Discussion Paper No.20, Glasgow: University of Strathclyde (March)
deSerres, A. and F. Pelgrin (2003) “The Decline In Private Saving Rates In The 1990s In OECD  Countries,” OECD Economic Studies No. 36, 2003/1
Elmendorf, D.W. and N.G. Mankiw (1998) “Government Debt,” NBER Working Paper 6470
Fry, M.J. (1980) “Saving, Investment, Growth and the Cost of Financial Repression,” World Development, 8, pp.317-327
Fry, M.J.(1995) Money, Interest and Banking in Economic Development (2nd ed.), Baltimore and London: Johns Hopkins University Press
Fry, M.J. (1997) “In Favour of Financial Liberalization,” The Economic Journal, 107(May), pp. 754-70
International Monetary Fund (2009): International Financial Statistics (Edition: February 2009). ESDS International, University of Manchester.
Jappelli, T. and M. Pagano (1994) “Saving, Growth and Liquidity Constraints,” Quarterly Journal of Economics, February, p. 83-109
Kalecki, M. (1937) “The Principle of Increasing Risk,” Economica, 4(16), pp. 440-447
Lopez-Mejia, A. (1991) “Excess Smoothness, Excess Sensitivity of Consumption and Financial Liberalization: The UK Evidence,” Department of Economics Paper No.239 (July), University of London, Queen Mary and Westfield College
McKinnon, R.I. (1973) Money and Capital in Economic Development, Washington DC: Brookings Institution
McKinnon, R.I (1993) The Order of Economic Liberalization: Financial Control in the Transition to a Market Economy, Baltimore: Johns Hopkins University Press
Organisation for Economic Cooperation and Development (2009): Main Economic Indicators (Edition: February 2009). ESDS International, University of Manchester.
Phelps, E. (1961) “The Golden Rule of Accumulation: A Fable for Growthmen,” The American Economic Review, 51(4), pp. 638-643
Rajan, R.G. (1992) “Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt,” The Journal of Finance, 47(4), pp. 1367-1400.
Ramsey, F. (1928) “A Mathematical Theory of Saving,” The Economic Journal, 38(December), pp. 543-559
Sawyer, M. (2006) “Kalecki on Money and Finance,” in Arestis, P. and M.C. Sawyer, A Handbook of Alternative Monetary Economics, London: Edward Elgar
Shaw, E.S. (1973) Financial Deepening in Economic Development, New York: Oxford University Press
Stiglitz, J.E. (1994) “The Role of the State in Financial Markets,” in M. Bruno and B. Pleskovic (eds) Proceedings of the World Bank Conference on Development Economics 1993, Washington DC: World Bank
Stiglitz, J.E. and M. Uy (1996) “Financial Markets, Public Policy and the East Asian Miracle,” World Bank Research Observer, 11(August), p. 249-276
Vittas, D. and Y.J. Cho (1996) “Credit Policies: Lessons from Japan and Korea,” World Bank Research Observer, 11 (August), p. 277-298
Williamson, J. and M. Mahar (1998) “A Survey of Financial Liberalization,” Princeton University Essays in International Finance No.211
World Bank (2008): World Development Indicators (Edition: December 2008). ESDS International, University of Manchester.

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