Economic Development and Financial Liberalisation

The suggestion has recently been put forward that interest rates should be freely determined by market forces whilst the central bank should set its own discount rate according to the needs of monetary policy. This thesis is clearly in accord with views regularly expressed by the IMF and the World Bank, especially for developing countries with financial systems that are subject to institutional restrictions on interest rates. The view that interest rate liberalisation is beneficial reflects not only monetary policy considerations, but also, and more importantly, wider developmental objectives. Its roots have a solid grounding in the work of the financial liberalisation school (McKinnon, 1973; Shaw, 1973; Gal-bis, 1977; Mathieson, 1980; Fry, 1988, 1989) and more recently in the endogenous growth literature (see for example Pagano, 1993). These approaches view the absence of any intervention in the pricing and allocation of loanable funds as a prerequisite for the promotion of financial deepening, which in turn is expected to have beneficial consequences on economic growth by raising the level and productivity of investment.