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Does financial liberalization really improve private investment in developing countries?

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  • Morisset, Jacques

Abstract

Assuming that liquidity constraints exist in most developing countries, the majority of analysts believe that increasing real interest rates will raise the volume of lending and hence private investment. The author, focusing on the demand for capital goods, argues that the positive effect on the domestic credit market may be offset by the negative effect of a portfolio shift from capital goods and public bonds into monetary assets. The author also demonstrates that a policy of financial liberalization could increase the public sector's demand for domestic credit, thus limiting the funds available to the private sector. This crowdingout does not result from a change in the government's behavior but from a shift in the portfolio of private agents. Higher demand for bank deposits reduces the private sector's willingness to hold government bonds, so the public sector must finance a given budget deficit with more domestic credit. Simulations for Argentina for 1961 - 1982 suggest that the low response of private investors to changes in interest rate policy in those 20 years was attributable not to the low values of interest elasticities but to the interaction of the mechanisms allowed for in the model, which tends to neutralize the impact of such policies. The author concludes that the effect of changes in interest rate policy on the demand for capital goods is weak in Argentina and might affect the quality of private investment more than its quantity.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 717.

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Date of creation: 31 Jul 1991
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Handle: RePEc:wbk:wbrwps:717

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Keywords: Economic Theory&Research; Environmental Economics&Policies; Banks&Banking Reform; International Terrorism&Counterterrorism; Macroeconomic Management;

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Cited by:
  1. Min Shrestha & Khorshed Chowdhury, 2007. "Testing financial liberalization hypothesis with ARDL modelling approach," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 17(18), pages 1529-1540.
  2. Baliamoune-Lutz, Mina N., 2006. "Financial Reform and the Mobilization of Domestic Savings: The Experience of Morocco," Working Paper Series, World Institute for Development Economic Research (UNU-WIDER) RP2006/100, World Institute for Development Economic Research (UNU-WIDER).
  3. Sunil Kumar Bundoo & Beealasingh Dabee, 1999. "Gradual liberalization of key markets: the road to sustainable growth in Mauritius," Journal of International Development, John Wiley & Sons, Ltd., vol. 11(3), pages 437-464.
  4. Jaramillo, Fidel & Schiantarelli, Fabio & Weiss, Andrew, 1993. "Capital market imperfections before and after financial liberalization : a Euler Equation approach to panel data for Ecuadorian firms," Policy Research Working Paper Series 1091, The World Bank.
  5. Anupam Das, 2012. "Remittance Behavior of Migrants and its Macroeconomic Effects in Four Developing Countries," International Journal of Applied Behavioral Economics (IJABE), IGI Global, IGI Global, vol. 1(1), pages 41-59, January.
  6. Philip Arestis & Santonu Basu, 2003. "Financial Globalization and Regulation," Economics Working Paper Archive wp_397, Levy Economics Institute.
  7. Berrak Buyukkarabacak & Stefan Krause, 2005. "Studying the Effects of Household and Firm Credit on the Trade Balance: The Allocation of Funds Matters," Emory Economics, Department of Economics, Emory University (Atlanta) 0510, Department of Economics, Emory University (Atlanta).
  8. Felix Eschenbach, 2004. "Finance and Growth: A Survey of the Theoretical and Empirical Literature," Tinbergen Institute Discussion Papers 04-039/2, Tinbergen Institute.
  9. Gupta, Kanhaya L. & Lensink, Robert, 1996. "Allocative efficiency and financial deregulation," International Review of Economics & Finance, Elsevier, Elsevier, vol. 5(1), pages 35-49.
  10. repec:dgr:uvatin:2004039 is not listed on IDEAS
  11. Gupta, Kanhaya L. & Lensink, Robert, 1997. "Financial repression and fiscal policy," Journal of Policy Modeling, Elsevier, Elsevier, vol. 19(4), pages 351-373, August.
  12. Fabio Schiantarelli & Andrew Weiss & Fidel Jaramillo, 1993. "Capital Market Imperfections Before And After Financial Liberization: An Euler Equation Approach To Panel Data For Ecuadorian Firms," Boston College Working Papers in Economics, Boston College Department of Economics 221, Boston College Department of Economics.
  13. Philip Arestis & Santonu Basu, 2003. "Financial Globalization: Some Conceptual Problems," International Trade, EconWPA 0301002, EconWPA.
  14. Santonu Basu, 2006. "Structural Problems in Financing Development: Issues Relating to India," International Review of Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 20(1), pages 85-101.
  15. White, Howard & Luttik, Joke & DEC, 1994. "The countrywide effects of aid," Policy Research Working Paper Series 1337, The World Bank.
  16. Gupta, Kanhaya L. & Lensink, Robert, 1995. "Foreign aid and the public sector : a simulation approach," Research Report 95D21, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
  17. Thandika Mkandawire, 1999. "The political economy of financial reform in Africa," Journal of International Development, John Wiley & Sons, Ltd., vol. 11(3), pages 321-342.
  18. Shrestha, Min B. & Chowdhury, Khorshed, 2005. "ARDL Modelling Approach to Testing the Financial Liberalisation Hypothesis," Economics Working Papers, School of Economics, University of Wollongong, NSW, Australia wp05-15, School of Economics, University of Wollongong, NSW, Australia.
  19. Lensink, Robert & Hermes, Niels & Murinde, Victor, 1998. "The Effect of Financial Liberalization on Capital Flight in African Economies," World Development, Elsevier, Elsevier, vol. 26(7), pages 1349-1368, July.

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