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.
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.
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.
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.
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