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Financial Market Liberalisation Wealth and Consumption - Literature review Example

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The following research paper "Financial Market Liberalisation Wealth and Consumption" deals with the operational characteristics of the credit market to critically examine why financial liberalizations continue to bring the financial crisis rather than efficiency to systems…
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Financial Market Liberalisation Wealth and Consumption
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Download file to see previous pages One can observe from that most of the reforms took between the 1970s and 1990s and mainly involved the elimination of interest rate ceilings and credit limits. Banks were also given more freedom to engage in mortgages. Financial liberalization has also been characterized by securitization.
Financial liberalization has been successful in that it has encouraged the formation of stock markets where they did not exist and has encouraged their deepening where they predated the reforms. (Grabel, 1995). For example, there has been an impressive expansion of stock markets in less developed countries (LDCs) following the adoption of financial liberalization in these countries. For example, Grabel (1995) notes that LDC stock markets listed some 5,531 domestic companies and had a market capitalization of US$86,125 million and an annual trading volume of US$23,672 million in 1980. By 1992, 36 LDCs had stock markets listing a combined total of 13,217 individual domestic companies with a combined market capitalization of US$774,093million as well as an annual trading volume of $594,685million. (Grabel, 1995).
Financial liberalization can be distinguished from financial repression, which according to McKinnon (1973) and Shaw (1973) is the “indiscriminate distortions of financial prices including interest rates and foreign exchange rates”. Financial repression reduces the real rate of growth as well as the real size of the financial system relative to nonfinancial magnitudes. (Fry, 1997). According to Shaw (1973: pp. 3-4) financial repression gravely retards the development process. The deregulation has been in part to improve efficiency in the financial system as well as improve the impacts on the business cycle and the transmission mechanisms of monetary and fiscal policies. (Boone et al., 2001). Financial liberalization has also been aimed at increasing competition in the financial services sector, through the rapid expansion of credit, which in turn eased liquidity constraints facing households, thus raising targeted levels of consumption. (Boone et al., 2001). This, in turn, increases aggregate demand, and thus real GDP and economic growth.
According to Fry (1997), Several interest-rate liberalization experiments have failed to produce positive outcomes. This is because there is a perverse reaction to higher interest rates by insolvent economic agents, governments, firms, or individuals. (Fry, 1997). An insolvent borrower is considered someone whose liabilities exceed his/her assets. Such borrower is not deterred from borrowing more to finance his/her losses no matter what interest rates may look like. Loans to insolvent borrowers, therefore, continue to increase because the borrower is not concerned about the level of interest rates. ...Download file to see next pagesRead More
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