Abstract
According to the advocates of financial liberalization in less developed countries (LDCs), a rise in the real interest rates is essential to stimulate savings, investment and the output growth rates. ‘Structuralists’, however, argue that such a rise in the real interest rates could lead to higher inflation, lower investment and lower output when such rates account for a major proportion of the total production costs and loanable funds can be diverted from the unorganized (UMM) to the organized money market (OMM). Here, we argue that it is difficult to decide in favor of any one of these conflicting views on a purely theoretical ground. A simple econometric model is set up to examine the validity of the conflicting theories in the light of the experience of financial liberalization in Sri Lanka. We also test the different aspects of invarance of structural parameters and the robustness of the model in the light of the “Lucas critique” that the model structure is likely to be affected by agents' expectations. We have found no evidence of such Lucas type critique of the model. Our results seem to confirm a positive and significant effect of financial liberalization on economic growth of Sri Lanka between 1950 and 1987.
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Financial help from the Nuffield Foundation to carry out part of this research is gratefully acknowledged. I am also very thankful to Professors Meghnad Desai, Wojciech Charemza, Henry Rempel and three anonymous referees of this journal for their comments and help in an earlier version of this paper. The usual disclaimer applies.
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Ghatak, S. Financial liberalization: The case of Sri Lanka. Empirical Economics 22, 117–129 (1997). https://doi.org/10.1007/BF01188173
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DOI: https://doi.org/10.1007/BF01188173