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Interest-Rate Liberalization and Capital Misallocations

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  • Zheng Liu
  • Pengfei Wang
  • Zhiwei Xu

Abstract

We study the consequences of interest-rate liberalization in a two-sector general equilibrium model of China. The model captures a key feature of China's distorted financial system: state-owned enterprises (SOEs) have greater incentive to expand production and easier access to credit than private firms. In this second-best environment, interest-rate liberalization can improve capital allocations within each sector, but can also exacerbate misallocations across sectors. Under calibrated parameters, the liberalization policy can reduce aggregate productivity and welfare unless other policy reforms are also implemented to alleviate SOEs' distorted incentives or improve private firms' credit access.

Suggested Citation

  • Zheng Liu & Pengfei Wang & Zhiwei Xu, 2019. "Interest-Rate Liberalization and Capital Misallocations," Working Paper Series 2017-15, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:2017-15
    DOI: 10.24148/wp2017-15
    Note: The first version of this paper was published May 2017.
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    8. Choi, Woo Jin & Roh, Woo Jin, 2023. "Service Matters: Capital Misallocation and Sectoral Economic Growth," KDI Journal of Economic Policy, Korea Development Institute (KDI), vol. 45(1), pages 1-32.
    9. Ding Dong & Zheng Liu & Pengfei Wang, 2021. "Turbulent Business Cycles," Working Paper Series 2021-22, Federal Reserve Bank of San Francisco.
    10. Li, Huiyu, 2022. "Leverage and productivity," Journal of Development Economics, Elsevier, vol. 154(C).
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    14. John Ammer & John Rogers & Gang Wang & Yang Yu, 2023. "Chinese Asset Managers’ Monetary Policy Forecasts and Fund Performance," Management Science, INFORMS, vol. 69(1), pages 598-616, January.
    15. Yang, Xiaoliang & Barros, Lucy & Matthews, Kent & Meenagh, David, 2023. "The dynamics of redistribution, inequality and growth across China s regions," Cardiff Economics Working Papers E2023/12, Cardiff University, Cardiff Business School, Economics Section.

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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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