We study the consequences of interest rate liberalization in a two-sector general equilibrium model of China. The model captures a key feature of China's distorted financial system: state-owned enterprises (SOEs) have greater incentive to expand production and easier access to credit than private firms. In this second-best environment, interest rate liberalization can improve capital allocations within each sector but can also exacerbate misallocations across sectors. Under calibrated parameters, the liberalization policy can reduce aggregate productivity and welfare unless other policy reforms are also implemented to alleviate SOEs' distorted incentives or improve private firms' credit access.
Liu, Zheng, Pengfei Wang, and Zhiwei Xu.
"Interest Rate Liberalization and Capital Misallocations."
American Economic Journal: Macroeconomics,
Interest Rates: Determination, Term Structure, and Effects
Financial Markets and the Macroeconomy
Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
Public Enterprises; Public-Private Enterprises
Socialist Systems and Transitional Economies: National Income, Product, and Expenditure; Money; Inflation
Socialist Enterprises and Their Transitions
Socialist Institutions and Their Transitions: Financial Economics