Free Theoretical Justifications Of Financial Liberalization Essay Example

Type of paper: Essay

Topic: Finance, Investment, Growth, Economics, Banking, Money, Development, Crisis

Pages: 2

Words: 550

Published: 2020/12/07


Financial Liberalization
Financial liberalization refers to the act of breaking away from the barriers financial repression. Actions of governments in the determination of interest rates coupled with the adverse consequences on the economy and financial sectors have a close association with financial repression. As a result, financial liberalization has a lot to do with free interest rates. In a bigger picture, financial liberalization process comprises of broader measures that seek to abolish restraints on the financial sector. Some of the measures include; removal of portfolio restrictions, external sector reforms, amendment of the institutional monetary policies framework, etc.
The connection that exists between financial development and economic growth follows two main financial approaches according to the financial repression theory; savings and investments approaches. The argument behind the savings approach is that economic growth results in the increase of lendable funds amounts, credit limits, and overall investments due to financial development. The main emphasis of this model is the significance of rules in enhancing the saving capacity that eventually opens up investment outlets.
The investment approach liberalization model, on the other hand, argues that investment does revolve around supply levels, but rather defines the savings via the income multiplier effect. The elaborate idea in this model is that high-interest rates have a negative impact on economic performance. Such is so because they discourage consumption and investment eventually reducing the demand. The Neo-Structuralism approach, a part of the savings analytical framework, has criticism revolving around the effect of financial liberation. The argument is that, financial liberalization might result in reduced loanable amounts for the entire financial system inclusive of unofficial money as well as capital markets.
Despite the unresolved status of the causality between economic growth and financial development, many less developed countries still underwent through the process of financial liberalization between 1980s and the early 1990s. They did this with the savings approach. The interpretation is that, there exist two contrasting outlooks regarding financial liberalization. On one hand, financial liberalization develops economic growth as well as fortifies financial development. The growth view relies on the estimated growth effects of financial liberalization. Such an approach only captures the average growth effect that result from financial liberalization. Financial liberalization policies are the main advocacies of researchers who give emphasis to the long-run growth. On the contrary, financial liberalization encourages extreme risk-taking behaviors, intensifies macro-economic impulsiveness, and frequently contributes to crises. The crisis view mainly emphasizes on the rigorousness of the output costs of financial crises, while ignoring growth benefits during quiet times. Researchers concentrating on crises advise against extreme financial liberalization.
A critical analysis of financial liberalization theories reveals the inadequacy of credit makers in setting limits for loan interest rates and also credit amounts. As a result, the notion attributing the liberalization of the financial system to enhanced levels of savings and investments becomes fragile by the day. Furthermore, inaccurate information coupled with and weak banking policy enactments reveal the reason for governments’ intervention in financial systems in an effort to avert crises. The dual effects of financial liberalization are observable from the contrasting experiences of Thailand and India. Thailand has a financially liberalized economy. As such, citizens are witnesses of lending booms and crises with a GDP per capital growth of 148% between 1980 and 2001 despite major crises. India has a non-liberalized economy, but its experience is that of a slow and steady growth path. During the same period, its growth per capita only grew by 99%.
Increasing empirical evidence showed the conventional view as wrong. Substantial capital flows have hit some of the wealthier emerging markets. However, other rich and poor emerging markets have had negligible or no capital flaws at all. On the overall, no evidence exists that relates financial liberalization to systematic economic growth and investment levels in emerging markets. On the contrary, there is evidence of consumption volatility as a result of financial liberalization. Empirical evidence also depicts financial liberalization as a cause of unstable domestic financial markets that are prone to crises.
The most vigorous finding, perhaps, is the substantial variance of the effects of financial liberalization across countries. Financial liberalization has dual effects. It tends to reduce borrowing constraints on one hand that leads to greater investments and higher average growth. On the other hand, it encourages risk-taking. As a result, there’s the creation of financial fragility as well as an increase in the likelihood of financial crises with often severe declining economic repercussions. Such effects of financial liberalization are dependent on a number of factors. They include; the wealth or poverty of a country, existence of developed or underdeveloped financial markets, and the presence of high or low-quality institutions.


Fry, M. (1988). Financial Repression and Capital Inflows. In Money, interest, and banking in economic development (p. 109). Baltimore: Johns Hopkins University Press.
Kunt, A., & Detragiache, E. (1998). Financial liberalization and financial fragility. Washington, DC: World Bank, Development Research Group and International Monetary Fund, Research Dept.

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"Free Theoretical Justifications Of Financial Liberalization Essay Example," Free Essay Examples -, 07-Dec-2020. [Online]. Available: [Accessed: 19-Apr-2021].
Free Theoretical Justifications Of Financial Liberalization Essay Example. Free Essay Examples - Published Dec 07, 2020. Accessed April 19, 2021.

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