Financial Liberalisation In New Zealand

The Impact on Savings and Investment

Phillip Mellor

The Theory

The Financial Sector and Economic Development

The McKinnon-Shaw Hypothesis The Complementarity Hypothesis

Savings and Physical Capital are complementary to one another

The Debt Intermediation View of Money Money is a form of debt to its issuer

The Financial Sector and Economic Development

The Role of the Financial Sector1. To facilitate trading, hedging, diversifying and

pooling of risk2. Allocating resources 3. Monitoring managers and exerting corporate

control 4. Mobilizing savings5. Facilitate the exchange of goods and services

Financial Development and Economic Growth Financial Intermediaries

Create money and administer the payments mechanism Bringing together savers and investors

Specialized knowledge and informational advantages Rationing via the interest rate

Stock Markets Promote acquisition of information about firms Risk diversification Liquidity services

Financial Development and Economic Growth Financial Repression

Holding interest rates below equilibrium and directed credit

The costs of financial repression Inefficient non-price rationing of credit Quasi-tax on growth Low savings

The benefits of limited financial repression Forcing households to save via credit constraints Overcoming market failure in financial markets (e.g. externalities and

information asymmetries)

Financial Liberalisation as a means of Financial Development

Measuring Financial Liberalisation Abiad and Mody’s (2005) index

Consequences of Financial Liberalisation Fragility of the financial sector

South Korea New Zealand?

Sequencing of Financial Liberalisation Reform of the real economy Then reform of the financial sector

The Case of New Zealand

New Zealand’s Decade of Reform Economic and Political Motivations for Reform

Economic Stagnation and Decline The 1984 election and initial public support

Theoretical Background Principal-Agent Theory Public Choice Theory

The Sequence of Reform

Real Gross Domestic Product

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

1960

1962

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1990

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1996

1998

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2004

Year

GD

P (

NZ

$m)

Real GDP, 1995/96 Prices

Financial Liberalisation in NZ

The Financial Sector pre-reform High degree of intervention and regulation Financial disintermediation

Sequencing of Financial Liberalisation

The Financial Sector post-reform Very open financial sector, virtually no specific

regulations

Investment

Key Point: Public and Private Investment have diverged following liberalisation

0.00

5.00

10.00

15.00

20.00

25.00

1960

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1992

1994

1996

1998

2000

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2004

Year

Inve

stm

ent

(% o

f R

eal

GD

P)

Private Investment Public Investment Total Investment

Savings

But there is a problem with how savings is measured

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

30.00

1960

1962

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1970

1972

1974

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1986

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1990

1992

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1996

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2000

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2004

Year

Sav

ing

s (%

of

No

min

al G

DP

)

Gross Domestic Savings (Claus and Scobie) Private Savings

Credit and the Money Supply

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

1960

1962

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1978

1980

1982

1984

1986

1988

1990

1992

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1998

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2004

Year

M2

(% o

f N

om

inal

GD

P)

M2 (RBNZ measure) Domestic Credit

The EvidenceEmpirical Results for the Case of New Zealand

Empirical Results

Empirical results for New Zealand indicate that financial liberalisation has had a positive impact on investment but a negative impact on savings

Estimated elasticities Financial Liberalisation-Investment = 0.112 Financial Liberalisation-Savings = -0.125

The estimated model also found some evidence that the Complementarity Hypothesis is relevant to the case of New Zealand

Conclusions Financial liberalisation has increased the share of total

investment to GDP Increased the efficiency of the financial sector Higher real interest rates more accurately reflect the scarcity of

financial resources and increase the real return to investors Increased the ability of firms and individuals to invest by reducing

credit constraints

Financial liberalisation has decreased the share of gross domestic savings to GDP Lower credit constraints make it easier to borrow for consumption /

investment rather than save. Transitional effects on savings behaviour as firms and individuals

adjust to the new financial and economic structure.

Questions?