IMPACT OF FINANCIAL LIBERALIZATION ON SAVINGS, INVESTMENT, AND MONEY DEMAND

Abstract

The financial liberalization hypothesis forwarded by McKinnon and Shaw in 1973 postulates that financial liberalization would induce higher savings, increase credit supply, stimulate investment and hence increase economic growth in developing economies that are financially repressed. The publication of these seminal works has motivated numerous empirical research which attempt to test the financial liberalization hypothesis. However, a comprehensive study using data from the Asian economies is still lacking despite the fact that these economics experienced moderate financial liberalization. Therefore, an attempt in this thesis is made to study the effects of financial liberalization in Korea ( 1970 to 199 5), Philippines (1980 to 1995) and Singapore ( 1978 to 1995), with particular focus regarding the effects of real interest rates, on savings, investment, economic growth and money demand. Econometric models of savings (total, private and financial), investment. economic growth1 and open-economy money demand are specified and then estimated using quarterly data. These models are re-estimated to test the pre and post liberalization effects where data suggests structural breaks. The direct impact of financial liberalization is to increase the flow of financial savings which increases the supply of credit. This would reduce the credit constraints faced by firms in financially repressed economies and would enable these firms to have sufficient funds available for investment. Such capital accumulation increases the rate of economic growth which then feedback to induce higher total, private and financial savings. Financial liberalization causes structural change in the money demand function by making foreign variables such as foreign interest rates and the exchange rate to be important arguments of the money demand function. 1 The title of the thesis should be "Impact or financial Liberalization On Savings, Investment, Economic Growth and Money Demand". During the course of researching this topic, I have extended the study to include economic growth. Due to some administrative constraints, I was not able to change the title.