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Published: 23-10-2012, 22:12

Financial repression

Financial repression: Rationale for and Types of Financial Repression

Financial repression: Impacts of Financial Repression

Financial repression refers to the notion that a set of government regulations, laws, or other nonmarket restrictions prevents an economy’s financial intermediaries such as banks and security markets from functioning at their full capacity. The policies that cause financial repression include interest rate ceilings, liquidity ratio requirements, high bank reserve requirements, capital controls, restrictions onmarket entry into the financial sector, credit ceilings or restrictions on directions of credit allocation, and government ownership or domination of banks. Economists have commonly argued that financial repression prevents the efficient allocation of capital and thereby impairs economic growth.

The economists McKinnon (1973) and Shaw (1973) were the first to explicate the notion of financial repression. While theoretically an economy with an efficient financial systemcan achieve growth and development through efficient capital allocation, McKinnon and Shaw argue that historically, many countries, including developed ones but especially developing ones, have restricted competition in the financial sector with government interventions and regulations. According to McKinnon and Shaw’s argument, a repressed financial sector discourages both saving and investment because the rates of return are lower than what could be obtained in a competitive market. In such a system, financial intermediaries do not function at their full capacity and fail to channel saving into investment efficiently, thereby impeding the development of the overall economic system.

See also asymmetric information; banking crisis; capital controls; capital flight; convertibility; financial liberalization; money supply; seigniorage

FURTHER READING

  • Ariyoshi, Akira, Karl Habermeier, Bernard Laurens, Inci Otker Robe, Jorge Iva´n Canales Kriljenko, and Andrei Kirilenko. 2000. ‘‘Capital Controls: Country Experi ences with Their Use and Liberalization.’’ IMF Occa sional Paper 190(May).Washington,DC: International Monetary Fund. Presents an overview of capital controls by discussing the role of capital controls and the current trend of capital account liberalization.
  • Beim, David, and Charles W. Calomiris. 2001. Emerging Financial Markets. New York: McGraw Hill. Discusses factors that contribute to the development of financial markets, especially those in emerging market countries. One of the chapters discusses the effect of financial re pression.
  • Claessens, Stijin. 2005. ‘‘Finance and Volatility.’’ In Managing Economic Volatility and Crises: A Practitioner’s Guide, edited by J. Aizenman and B. Pinto. Boston: Cambridge University Press, 213 80. Reviews the aca demic literature on the determinants of financial mar kets; the role of financial markets in economic devel opment; the potential impact of domestic financial deregulation; and the effect of financial volatility on the economy.
  • Kaminsky, Graciela, and Sergio Schmukler. 2002. ‘‘Short Run Pain, Long Run Gain: The Effects of Financial Liberalization.’’ World Bank Working Paper No. 2912. Washington, DC: World Bank. Examines empirically the short and long run effects of financial liberalization on capital markets and finds financial liberalization can lead to pronounced boom bust cycles in the short run, but more stable markets in the long run.
  • McKinnon, Ronald I. 1973.Money and Capital in Economic Development. Washington, DC: Brookings Institution. A seminal work along with Shaw (1973) in which the author defines financial repression and identifies it in the development of financial markets in countries.
  • Montiel, Peter. 2003.Macroeconomics in Emerging Markets. Cambridge: Cambridge University Press. Provides mac roeconomic theories andmodels especially for emerging market countries. A few chapters in the book present academic discussions about financial repression and the impact of financial liberalization.
  • Roubini, N., and X. Sala i Martin. 1992. ‘‘Financial Re pression and Economic Growth.’’ Journal of Develop ment Economics 39: 5 30. One of the first papers that empirically analyzes the negative effects of financial re pression on economic growth.
  • Shaw, Edward. 1973. Financial Deepening in Economic De velopment. New York: Oxford University Press. Along withMcKinnon (1973), this book is a seminal work that defines financial repression and examines the effect of financial development on economic development.

HIRO ITO

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