Financial Liberalisation and Economic Development
1.1. Introduction
This paper examines the effect of financial liberalisation (FL) on economic development in less developed countries (LDC). The paper is divided into several sections; the first examines the concept of financial repression and the second introduces the Mckinnon-Shaw thesis of financial liberalisation; section three looks at the critique of Mckinnon-Shaw thesis. This paper presents some evidence that will indicate a positive relationship between financial liberalisation and economic development (e.g. growth rate). However, this relationship is not robust. In other words, there are still controversies over the affects of financial liberalisation in LDC’s. Also, this paper will look at the experiences in financial liberalisation in Indonesia.
2.1. Financial repression
For many years, governments across the globe followed a policy of financial repression. Financial repression comes in many forms. Under financial repression nominal interest rates are set below market level, there is control of credit allocation, high reserves requirements and financial system is highly regulated and controlled. The rational for financial repression originates from Keynesian economics and Tobin’s portfolio allocation model.
The Keynesian model states that savings (S) and investment (I) are equal. Keynes assumed that interest rates are determined in the money market. In his model consumption function is an important element. Furthermore, Keynes argues that investment is autonomous, while the level of savings varies with income. Keynesian theory promotes government involvement in the market. The rational for financial repression rises from the Keynesian assumption that a low level of interest rate stimulates the level of investment and increased investment will increase income and hence savings. It is assumed that a rise of income level will increase aggregate demand and that will increase the level of output. Thus, by boosting investment and output there
This paper examines the effect of financial liberalisation (FL) on economic development in less developed countries (LDC). The paper is divided into several sections; the first examines the concept of financial repression and the second introduces the Mckinnon-Shaw thesis of financial liberalisation; section three looks at the critique of Mckinnon-Shaw thesis. This paper presents some evidence that will indicate a positive relationship between financial liberalisation and economic development (e.g. growth rate). However, this relationship is not robust. In other words, there are still controversies over the affects of financial liberalisation in LDC’s. Also, this paper will look at the experiences in financial liberalisation in Indonesia.
2.1. Financial repression
For many years, governments across the globe followed a policy of financial repression. Financial repression comes in many forms. Under financial repression nominal interest rates are set below market level, there is control of credit allocation, high reserves requirements and financial system is highly regulated and controlled. The rational for financial repression originates from Keynesian economics and Tobin’s portfolio allocation model.
The Keynesian model states that savings (S) and investment (I) are equal. Keynes assumed that interest rates are determined in the money market. In his model consumption function is an important element. Furthermore, Keynes argues that investment is autonomous, while the level of savings varies with income. Keynesian theory promotes government involvement in the market. The rational for financial repression rises from the Keynesian assumption that a low level of interest rate stimulates the level of investment and increased investment will increase income and hence savings. It is assumed that a rise of income level will increase aggregate demand and that will increase the level of output. Thus, by boosting investment and output there