Effects on Economic Growth by Financial Repression Essay

Effects on Economic Growth by Financial Repression - Essay Example The McKinnon-Shaw hypothesis recommended the liberalisation of the financial sectors from such restrictions to stop economic stagnation and initiate economic growth. This hypothesis, however, is not without its share of critics who pointed out that severe financial repression must be distinguished from mild repression or that the McKinnon-Shaw framework failed to take into certain factors such as inflation or that some of its basic components lacked empirical basis. Moreover, specific studies of countries that adopted this financial repression yielded unequivocal results that could lead one to assert that financial repression leads only to one and only one result - economic stagnation. In connection with this, the cases of India and China, both of which have experienced financial repression, are presented in this paper to shed light to the McKinnon-Shaw claim that financial repression negatively affects economic growth. This is timely considering that both, especially China, are pres ently considered emerging super economies of the world. Financial repression is a term that was first coined in the 1970s by McKinnon and Shaw, but was actually a condition that existed prevalently before that. As a matter of fact, financial repression was the norm and financial liberalisation, its opposing term, the exception prior to the 1980s. Financial repression, thus, refers to government intervention in the financial environment by substituting regular market variables and mechanisms with its own (Spratt 58). The existence of financial repression can be deduced from the presence of the following factors: unsystematic distortions in financial prices such as interest and exchange rates; interest rates with ceiling caps and nominal interest at fixed rates, which lead to low or even negative real interest rates.